CHOICE OF ENTITY

1. CHOICE OF ENTITY Presented by: Belarmino A. Suarez, CPA Mendonca & Suarez Financial Services LLC, CPAs Roy Carrasquillo, Esq. Gibbons, P.C. January 4, 2010 Program for USHAA.COM

2. CHOICE OF ENTITY • The "choice of entity" decision is one of the most important decisions facing new business owners. There are several forms to choose from, each of which generates different legal and tax consequences. • Choosing the appropriate form of entity in which to operate a business is a complex decision. It depends upon many factors, including the owners' needs and desires and the particular characteristics and needs of the business in question. Federal and state tax consequences of each type of entity also play an important role, especially in closely held entities where the parties' combined tax liabilities should be analyzed as part of the decision-making process.

3. CHOICE OF ENTITY • Performing this assessment requires an understanding of not only the major tax and nontax aspects of each form of business, but also of how the comparative advantages and disadvantages of each relate to the needs of a specific business owner. The decision involves multiple levels of questions. The answers to some questions serve to immediately eliminate the use of certain kinds of entities. The remaining questions elicit answers to questions that can be weighted in favor of one type of entity, versus another.

4. CONSIDERATIONS FOR CHOICE OF ENTITY • Nature of the business Inventory or services Employees and fringe benefits Risks/liability exposure Availability of medical reimbursement plan • Start-up owners Number Relationship Investor only or employees Compensation levels

5. CONSIDERATIONS FOR CHOICE OF ENTITY • Assets to be contributed Identify tentative opening assets and liabilities Potential appreciation Goodwill value • Capitalization / Ownership / Investors Multiple owners/investors/new investors Stock and/or debt Voting vs. nonvoting ownership Likelihood of withdrawal by shareholder, partner or member Likelihood of transfer of shares or interests Likelihood of going public Equity growth or income

6. CONSIDERATIONS FOR CHOICE OF ENTITY • Owner liability Personal guarantees required Professional service entity with only partial liability protection Owners personally exposed via employment Legal counsel to assess liability protection under corporation vs. LLC vs. LLP vs. limited partnership? Limitation of potential liability • Governance / Management control Who? Transition plan to successors Who will have management and control of the business? Is an entity needed that allows investors without management involvement? Will management expand?

7. CONSIDERATIONS FOR CHOICE OF ENTITY • Expected profitability Early years Later years Retain or distribute earnings • Owners’ exit strategies Gift or bequest Sale of assets Is a stock sale viable? Termination/liquidation and when Continuity, and transferability of ownership What is the expected duration of the business? Is a form of ownership needed that provides ease of transferability?

8. CONSIDERATIONS FOR CHOICE OF ENTITY • Registration and administration State registration Legal documents Ongoing compliance, reports • Tax Savings Income tax / double tax Payroll/self-employment tax Estate tax minimization Use of anticipated early year losses

9. TYPE OF ENTITY • In most jurisdictions, the entrepreneur has as many as nine choices available when making an entity selection decision. The choices are as follows: • Proprietorship • Four forms of partnership • general partnership • limited partnership • limited liability company (New Jersey Default Provision) * • limited liability partnership

10. TYPE OF ENTITY • S corporation • Three forms of C corporation • regular C corporation • personal service corporation • Section 1202 qualified small business corporation

11. TYPE OF ENTITY * Limited Liability Company is a legal entity formed under state law by filing articles of organization with the secretary of state. Limited liability companies are owned by members and with the liability protection of a corporation. A newly formed domestic eligible entity that does not file a classification election will be classified as a partnership (if it has two or more members), or disregarded as an entity separate from its owner and treated as a proprietorship (if it has only one owner).

12. GENERAL ADVANTAGES AND DISADVANTAGES OF EACH TYPE OF ENTITY PROPRIETORSHIPS • Advantages • Ease of formation. • Simple to operate. • Easy to sell assets. • Fewer administrative burdens. • All taxation to owner. • Disadvantages • Limited source of capital. • No limited liability for owner. • No continuity past proprietor. • All net income subject to SE tax.

13. GENERAL ADVANTAGES AND DISADVANTAGES OF EACH TYPE OF ENTITY GENERAL PARTNERSHIPS • Advantages • More sources of capital. • More management resources. • Less administration than corporations. • Pass-through taxation to owner, with flexible allocations possible. • Disadvantages • Transfer of interests is more difficult than stock or limited liability units. • Each general partner is personally liable. • All net income is subject to SE tax. • Complexity of partnership tax rules.

14. GENERAL ADVANTAGES AND DISADVANTAGES OF EACH TYPE OF ENTITY LIMITED PARTNERSHIPS Similar to general partnerships, except: • Advantages • Limited partners (but not general partner) have limited liability. • Limited partners are generally not subject to SE tax. • General partner can retain management control, and yet decrease equity to reduce estate tax. • Disadvantages • A general partner’s assets could be seized to satisfy debts of the limited partnership. • Valuation issues with two classes of units.

15. GENERAL ADVANTAGES AND DISADVANTAGES OF EACH TYPE OF ENTITY C CORPORATIONS • Advantages • Easier to raise capital with stock sales. • Owners have limited liability. • Corporations have perpetual life. • Ease of transferability of stock. • More management resources. • Disadvantages • Subject to double taxation on both earnings and inside gains. However, the 2003 Tax Act has reduced this disadvantage by lowering the tax rates on long-term capital gains and qualifying dividends. • More administrative burdens. • Difficult to form and to dissolve. • Borrowing generally requires stockholder guarantees.

16. GENERAL ADVANTAGES AND DISADVANTAGES OF EACH TYPE OF ENTITY S CORPORATIONS • Advantages • Pass-through status avoids double taxation. • Owners have limited liability. • Individual tax rates may be lower than the applicable corporate rates. • Distributions from the S corporation are exempt from payroll taxes (assuming adequate compensation to employee-shareholders). • Disadvantages • Number of shareholders limited to 100. • Only one class of stock permitted. • No corporate, partnership, or nonresident alien shareholders. • Calendar year requirement. • Lack of tax-free fringe benefits to more-than-2% shareholders. • Individual tax rates on the pass-through income may be higher than applicable corporate rates. • Shareholders must directly invest to have basis to support loss pass-through; guarantee of entity debt is insufficient.

17. GENERAL ADVANTAGES AND DISADVANTAGES OF EACH TYPE OF ENTITY LIMITED LIABILITY COMPANIES • Advantages • All members have limited liability. • The number of members is not limited. • Members may be corporations, trusts, partnerships, other LLCs, or others. • Pass-through taxation to the members under partnership principles. • Distributions to members can include special allocations. • Members may participate in management. • Different classes of ownership are permitted.

18. GENERAL ADVANTAGES AND DISADVANTAGES OF EACH TYPE OF ENTITY LIMITED LIABILITY COMPANIES • Disadvantages • They may have a limited life. • Transferability of interests may be limited. • LLC laws vary from state to state. • LLC liability protection is relatively untested in the court • Members who have management authority, debt responsibility, or who materially participate are exposed to SE tax.

19. GENERAL ADVANTAGES AND DISADVANTAGES OF EACH TYPE OF ENTITY LIMITED LIABILITY PARTNERSHIPS Similar to general partnerships, except: • Advantages • Permitted under the laws of many states to provide a partner of a professional firm with partial liability protection (liability remains for the partner’s own acts, but liability protection exists for actions of other LLP partners and employees). • Pass-through taxation of partnership status. • Flexibility to structure ownership interests. • Disadvantages • Partners are generally liable for the debts and other obligations of the LLP (except for the professional acts and omissions of other partners or employees).

20. SUMMARY Careful consideration should be given to the different options available to entrepreneurs when choosing the most appropriate form of conducting business. All of these entity choices have significant legal and tax significances which when not aware of can have an adverse affect on the ultimate objective. We recommend that you consult with your legal counsel and your tax adviser to make sure that they understand the nature of your business and objectives in order to assist you in making the right choice of entity for your business.