Why Use a Partnership Instead Of An S Corp

Federal Taxation of Partnerships and S-Corporations
As the title of the 2014 article “Why Use a Partnership Instead Of An S-Corp?” suggests, one of the primary criteria in selecting one particular entity type over another is the question of tax liability. In contrast to a C-corporation, in the case of a partnership or S-corporation, the income of the entity is not taxed; rather the partners and shareholders are taxed at standard rates. Income is not taxed at the entity level. It passes through to partners and shareholders and is taxed though them at their individual, personal tax rates. Of course, this raises the question of why become a C-corporation in the first place. But for very large entities, the benefits of legal fictional personhood are great, given that means that shareholders are not responsible for any debts or other legal liabilities generated by the C-corporation. In contrast, an S-corporation exists as an entity for federal tax purposes (“Why Use a Partnership Instead Of An S-Corp,” 2014).
Although they share some similar features, partnerships and S-corporations also share some critical differences. Partnerships function very much like sole proprietorships. They are very simple to set up, legally speaking. For a small business organization that just happens to be the brainchild of two people, partnerships have many advantages. Yet the partners are also legally liable for the debts of the partnership, because there is no separation between the entity and the joint proprietors. On the other hand there is no risk of double taxation of the partners’ incomes and profits derived from the corporation.
Another advantage of a partnership is that any individual can be a partner and there are no limits upon the number of partners. In contrast, given that an S-corporation is designed to limit the scope and size of an incorporated entity, to make it distinct from the large, publically-traded C-corporation, there is a limit of 100 shareholders for S-corporations. S-corporations, unlike C-corporations, are also only permitted to issue one class of stock (“Why Use a Partnership Instead Of An S-Corp,” 2014). The ability of an S-corporation to generate revenue is thus more limited than that of a C-corporation. A partnership is likewise prohibited from selling shares to raise stock, although it is permitted to have different types of partners with different percentages of interest in the partnership (“Why Use a Partnership Instead Of An S-Corp,” 2014). This can, to some degree, act to mitigate the liability risk for some partners, as individuals with less of an investment and stake in the partnership may be may made liable for fewer of the entity’s debts; they also do not share in its tax burden although they are likewise less able to profit from it, versus those individuals with a greater stake in the partnership (“Why Use a Partnership Instead Of An S-Corp,” 2014).
A final distinction for tax purposes between S-corporations and partnerships pertain to that of appreciated property, which are not taxable if contributed by a partner in the partnership. With an S-corporation, they are only not taxable if “the shareholders are part of a group controlling 80% of the corporation after the contribution,” although “a partnership must follow special allocation rules for handling built-in gain on contributed property, whereas S-corporations do not have special allocation rules in this circumstance” (“Why Use a Partnership Instead Of An S-Corp,” 2014, par.8). Still, the main, deciding factor regarding whether to incorporate or to remain a partnership is that of legal liability for the entity’s debts, versus the concerns about being taxed twice on one’s income devoted to preserving the S-corporation and the moneys received as profits.



References
Why use a partnership instead of an S-Corp? (2014). Dulin, Ward & DeWald. Retrieved from:
https://dwdcpa.com/blog/why-use-a-partnership-instead-of-an-s-corp