Choosing a Business Form 255regulations provide that these entities will be taxed as partnerships unless the
entity affirmatively chooses to be taxed as a corporation. Most corporations
have already achieved that level of comfort through the availability of the sub-
chapter S election.
Although the LLC would seem to have the advantage of affording tax
pass-through treatment without the limitations of the subchapter S corporation
rules, there are some disadvantages as well. Since the nonelecting LLC is not a
corporation, it is not eligible for certain provisions the Internal Revenue Code
grants only to the corporate entity. Among these privileges are the right to
grant incentive stock options (ISOs) to employees and the right to take advan-
tage of tax-free reorganizations when selling the company. LLCs must be con-
verted to taxable entities well before relying on these provisions.
CHOICE OF ENTITY
The sole propr ietorship, par tnership, cor poration (including the professional
corporation and subchapter S corporation), the limited partnership, and the
LLC are the most commonly used business forms. Other forms exist, such as
the so-called Massachusetts business trust, in which the business is operated by
trustees for the benefit of beneficiaries who hold transferable shares. But these
are generally used for limited, specialized purposes. Armed with this knowl-
edge and the comparative factors discussed previously, how should our budding
entrepreneurs operate their businesses?
Consulting Firm
It will be obvious to Jennifer, Jean, and George that they can immediately
eliminate the sole proprietorship and limited partnership as choices for their
consulting business. The sole proprietorship, by definition, allows for only one
owner, and there does not seem to be any need for the passive silent investors
who would serve as limited partners. Certainly, none of the three would be
willing to sacrifice the control and participation necessary to achieve limited
partnership status.
The corporation gives the consultants the benefit of limited liability, not
for their own mistakes but for the mistakes of each other and their employees.
It also protects them from personal liability for trade debt. This protection,
however, comes at the cost of additional complexity and expense, such as ad-
ditional tax returns, annual reports to the state, and annual fees. Ease of trans-
ferability and enhanced continuity do not appear to be deciding factors,
because a small consulting firm is often intensely personal and not likely to be
transferable apart from its principals. Also, fear of double taxation does not
appear to be a legitimate concern, since it is likely that the stockholders will
be able to distribute any corporate profit to themselves in the form of
compensation. In fact, to the extent that they may need to make some capital