Why use partnership instead of an S corp?

A person who wants to run his/her own business has a variety of choices like  C corporationS corporation, limited liability company, or a sole proprietorship which can be operated by a single individual. More than one individual can form a partnership, a corporation (C or S) or an LLC.

There is a number of significant effects, especially in management and taxes whether you choose S corporation or any partnership. On one hand a partnership is basically an association of people who run a business together and on the other hand S corporation allows the owners to take advantage of taxation while still maintaining the benefits of limited liability.

PartnershipS corporation
Formation

In partnership formation, no paperwork is required. In fact, you can create a partnership without even intending to do so if you and another person start working together on a business. All you need is a handshake and you are in partnership.

An S corporation requires more complex registration requirements. Firstly, the business must get register as a corporation or limited liability corporation in the state in which it’s doing business. It generally requires creating either article of incorporation or articles of organization. IRS Form 2553 must be completed by the company to form an S corp.
FlexibilityPartnerships are more flexible in terms of the structure of the company like in management, profit and even in the loss allocations. Regardless of ownership, the default provision is that all partners have an equal say but the partners can agree to another arrangement. For instance, in partnership, partners could agree that one partner will act as the managing partner and make all the day-to-day decisions. Even partners could also contract for different shares of profits and losses, regardless of ownership interest.

S corporation structure is quite rigid compared to the partnerships.S corporation shareholders elect a board of directors that oversees the management of the company, and they appoint officers to oversee the day-to-day operations. In addition, S corporation allocations of profits and losses must be made on the basis of shares owned and no alterations can be made.

TaxationBeing a member of Partnership, the IRS considers your income self-employment income. It simply means you are responsible for paying self-employment taxes in addition to income taxes because they are self-employed, partners don’t have any money withheld by an employer, that means they typically must make estimated tax payments.

S corps are more complicated when it comes to tax treatment. S corp owners must pay themselves a “reasonable salary” for the work that they do for the business. It then counts as employee income, which means the S corp owner receives a W-2 form. The remainder of the income from the S corp passes through to the owners and is taxed as ordinary income tax rates.

Personal asset protection

There is no legal separation between the partners and their company in general partnership. If the company got sued or incurs a debt, the partner’s personal assets are to pay off any claim.

An S corporation shareholders personal assets normally cannot be seized to pay off any debts or claims held against the corporation.
Courts, however, can “pierce the corporate veil”. If a judge rules the corporation does not maintain a separate financial identity from its owners.

Advantages of partnership

  • In S corporation, there is a limitation of 100 shareholders. Only certain individuals, estates, and trusts are eligible to be shareholders. But in partnership, anyone or any entity can be a partner
  • A partnership can have different classes of partners and has more flexibility for allocating income. Also, the losses as compared to S corporation as S corporations are limited to a single class of stock; income and losses must be allocated on the same basis to each shareholder.
  • Partnership liabilities can increase a partner’s basis in the partnership, offsetting distributions of cash and reducing their taxation. The increased basis allowed partners to use losses generated by the partnership. An S corporation does not create separate bases in stock. And hence, a debt must be calculated. This lack of basis may limit the use of losses generated by the S corporation.
  • Contributions made by a partner of a appreciated property are not generally not taxable. Even if the partner is not part of a group

controlling the partnership and the contributions by a shareholder to a corporation are tax-free. Only if the shareholders are part of a group controlling 80 percent of the corporation after the contribution.

Conclusion

In simple words, a partnership somehow offers more flexibility than an S corporation in the treatment of taxes. However, General partners are not isolated from the partnership’s debts and liabilities. While S corporation shareholders do have limited legal liability

Related Topic: Which one is better: C corp or S corp?

By | 2018-08-07T16:26:46+00:00 June 27th, 2018|Taxation|Comments Off on Why use partnership instead of an S corp?

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