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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 knowledge 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, no one 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
additional tax returns, annual reports to the state, and annual fees. Ease of transferability 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 expenditures for computers and office furniture, the corporate form would
afford them access to the lower corporate tax brackets for small amounts of income (unless they fell
victim to characterization as a personal service corporation). Furthermore, if the consultants earn
enough money to purchase various employee benefits, they will qualify as employees of the
corporation and can exclude the value of such benefits from their taxable income, while the
corporation deducts these amounts.
These positive aspects of choosing the corporate form argue strongly against making the subchapter
S election. That election would eliminate the benefit of the low-end corporate tax bracket and put our
consultants in the position of paying individual income tax on the capital purchases made. The
election would also eliminate the opportunity to exclude the value of employee benefits from their
personal income tax. The same problems argue against the choice of an LLC (or LLP) for this
business.
The other possibility would be the general partnership. In essence, by choosing the partnership, the
consultants would be trading away limited liability for less complexity. The partnership would not be
a separate taxable entity and would not be required to file annual reports and pay annual fees. From a
tax point of view, the partnership presents the same disadvantages as the subchapter S corporation and
the LLC.
In summary, it appears that our consultants will be choosing between the subchapter C corporation
and the partnership. The corporation adds complexity, but grants limited liability. And it certainly is
not necessary for a business to be large in order to be incorporated. One might question, however, how
much liability exposure a consulting firm is likely to face. In addition, although the corporation
affords them the tax benefits associated with employee benefits and capital expenditures, it is not