When starting a business (whether it is forming a business based out of your home, opening a small “mom and pop” store, or establishing a business where you buy and sell real estate), choosing the type of business entity to form (for example, an “S-Corporation” or a limited liability company) will be one of your important decisions. The wrong decision may have adverse consequences. Pennsylvania law imposes several taxes on corporations and limited liability companies that are not applicable to limited partnerships.
A limited partnership is a partnership made up of one or more general partners and one or more limited partners. A limited partnership derives its authority from the Pennsylvania Limited Partnership Act, although the partners may prepare a limited partnership agreement governing their rights and obligations. The general partner is the equivalent of a partner in a traditional partnership (in other words, where all of the partners have the same status). The general partner has day-to-day control of the limited partnership and is responsible for all debts of the limited partnership. The limited partner, on the other hand, does not have any personal liability beyond the capital contributions he makes to the limited partnership, and has no or almost no management authority. As such, the limited partner is analogous to a shareholder of a corporation. Typically, the general partner will own 1% or less interest in the limited partnership; the limited partner will own the remainder. Both individuals and business entities can be general partners or limited partners. (By contrast, non-individuals may not own shares of an S-Corporation.)
Pennsylvania imposes a corporate net income tax and a capital stock tax on corporations but not partnerships. Although Federal tax law generally treats a limited liability company as a partnership, Pennsylvania treats a limited liability company as a corporation for tax purposes. Thus, under Pennsylvania law, limited liability companies do not have as many tax advantages as limited partnerships. The corporate net income tax rate is 9.99% of the entity’s net income. The capital stock tax is calculated according to the following statutorily-fixed formula: the product of � times the sum of the average net income capitalized at the rate of 9.5% plus 75% of net worth, from which product shall be subtracted $150,000. Although partners of a limited partnership will have to pay taxes that are the equivalent of corporate net income tax, there is no equivalent of the capital stock tax.
Tax consequences are only one factor that should be used when deciding what entity to form. Other factors, such as the controlling principal’s liability and the entity’s management structure, may be equally important. The decision should be governed by the individual circumstances of each new enterprise. If you have any questions on which entity will be right for your business, please contact us.
– Andrew Berenson