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Key Tariff Strategies for Future-Proofing Your Business

Posted on May 28, 2025June 2, 2025 by don@mbn.io

May 28, 2025 | by Atherton & Associates, LLP

The global trade environment has become increasingly complex due to recent announcements of universal tariff increases and heightened reciprocal rates for certain countries. While the media often highlights the political angles of these changes, businesses must take practical steps to avoid costly pitfalls. Tariffs can alter operating costs, disrupt supply chains, and affect pricing strategies—regardless of a company’s size or industry. Building a proactive plan to address these challenges can make all the difference in maintaining profitability and future-proofing your business.

This article explores what tariffs mean, why they matter, and how you can respond with a forward-looking mindset. By implementing the right strategies today, you can boost your resilience against shifting trade policies in the years to come.

Understanding Tariffs and Their Scope

Tariffs are government-imposed taxes on imported goods. When U.S. businesses import items from overseas—whether raw materials, components, or finished products—they typically pay these taxes at the point of entry. The specific rates vary depending on how a product is classified, its country of origin, and the overall trade climate. Some tariffs are calculated as a percentage of the product’s value (an ad valorem tariff), while others are a fixed fee per unit (a specific tariff).

In the United States, tariffs are not administered by the Internal Revenue Service or the Treasury Department. Rather, they fall under the Department of Homeland Security’s Customs and Border Protection. Its role includes collecting duties, enforcing compliance with customs regulations, and responding to evolving trade policies. Governments impose tariffs for multiple reasons, including generating revenue, protecting domestic industries, and regulating imported goods.

The Impact of Tariffs on Businesses

Although large multinational corporations are often in the spotlight, the scope of tariff impact extends to businesses of all sizes. A company’s reliance on imports, existing contractual obligations, and market dynamics can determine how hard these tax changes hit. There are several key areas of concern:

Supply Chain Challenges. Tariffs can make originally cost-effective supply chains suddenly more expensive. If your business depends on overseas producers, shifting trade rules may leave you scrambling for domestic or alternative international sources. This uncertainty can throw off inventory management, especially if certain products are subject to steep import taxes.

Pricing Adjustments. Higher costs from tariffs might compel you to adjust your pricing strategy. Businesses must decide whether to absorb the added expense—risking margins—or pass it on to customers. Small and medium-sized enterprises in particular may find it difficult to shoulder these added costs, so a carefully crafted approach to raising prices can help preserve customer goodwill.

Financial Reporting Implications. When you’re recalculating cost of goods sold, tariff expenses cannot be overlooked. Accurately attributing these additional fees to your product costs is vital for precise financial reporting and to maintain a realistic picture of profit margins. If your business is publicly traded, transparent reporting on the implications of tariffs is often expected by stakeholders.

Special Considerations for Small Businesses. Smaller companies may feel a disproportionate impact because they often operate on narrower profit margins. Moreover, many small businesses rely on strong, enduring relationships with overseas suppliers, which can be costly to shift or rebuild elsewhere. For certain organizations, adjusting product lines or seeking new supply channels may be necessary to sustain operations in the face of changing tariffs.

Key Strategies for Future-Proofing Against Tariffs

Though trade policies can change quickly, there are several approaches that businesses can adopt to navigate uncertainty and remain resilient. By implementing these strategies, you position your organization to adapt as conditions evolve:

1. Review and Update Existing Contracts and Agreements. Take a fresh look at your current supplier and vendor contracts. Some agreements include provisions that address sudden shifts in tariffs, allowing for renegotiation or flexibility in purchase commitments. You might find “force majeure” clauses or language specific to tariff escalation. Checking these details early can provide a roadmap for making adjustments without facing heavy penalties.

2. Assess Alternative Sourcing and Supply Chain Diversification. If tariffs substantially increase costs, investigate options in lower-tariff jurisdictions or even domestic alternatives. Although moving production or finding new suppliers can be disruptive, in some cases it may be more cost-effective in the long run. Even for businesses that remain dependent on certain imports, diversifying the supply chain to include multiple sources reduces vulnerability to tariff hikes in any one region.

3. Cost Management and Pricing Strategy. Calculating the overall financial impact of tariffs can help guide your decisions on product pricing. Some companies opt for transparent “tariff surcharges” so customers and partners understand these added costs arise from external factors. Striking the right balance between profitability and customer loyalty can be challenging, but a phased or clearly labeled price adjustment can make it more palatable.

4. Leverage Duty Exemptions and Relief Programs. You might qualify for exemptions under trade agreements such as the USMCA if your imports meet specific origin criteria. Duty drawback programs can also offer a rebate if you import goods but subsequently export them. Additionally, operating within a Foreign Trade Zone (FTZ) may allow you to defer or reduce some of your duties until the goods leave the zone. Staying informed about legislative updates and special exemption windows can result in significant savings.

5. Implement Robust Scenario Planning and Compliance Tools. Technology can be a powerful ally in uncertain times. By using predictive analytics or supply chain management software, you can model multiple tariff scenarios and evaluate where costs might spike. This ensures you’re ready to pivot quickly if conditions worsen. The right software can also aid in compliance, reducing the risk of fines for misclassifying products under the Harmonized Tariff Schedule.

6. Seek Expert Guidance. Tariff regulations are highly nuanced, with shifting deadlines and complex definitions. Enlisting a professional who understands international tax policies, supply chain logistics, and customs regulations can be invaluable. An expert may identify hidden cost-saving measures or clarify potential liabilities you hadn’t considered. Act early, before new rules or deadlines take effect, to avoid last-minute scrambling.

Securing Strength Amid Trade Shifts

From increased costs and inventory disruptions to the financial complexities of assigning tariff-related expenses, tariff regulations create pressure points across the entire business landscape. The most resilient organizations are those that move now, assessing vulnerabilities, rewriting contracts, and diversifying their sourcing setups. Thoughtful planning—backed by professional expertise—can turn tariff upheavals into opportunities for renewed efficiency and stronger partnerships.

Acting with a sense of urgency could be the difference between sinking or swimming in our new tariff trade environment. With the right strategies in place and expert advice at your side, you can protect your bottom line and secure success amid ongoing changes in tariff policy.

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Client Alert: Major Federal Tax Reform Heads to Senate

Posted on May 27, 2025June 2, 2025 by don@mbn.io

May 27, 2025 | by Atherton & Associates, LLP

Client Alert
House Passes ‘One Big Beautiful Bill’: Key Tax Provisions and Next Steps

May 27, 2025
From the Office of Jackie Howell, CPA, Tax Partner

On May 22, 2025, the U.S. House of Representatives narrowly passed the “One Big Beautiful Bill,” a comprehensive tax and spending package championed by President Trump. The bill now advances to the Senate, where further deliberations are anticipated.

Highlights for Individual Taxpayers

Permanent Extension of 2017 Tax Cuts: Permanently adopts the modified federal income tax brackets and reduced rates established by the TCJA, with an inflation adjustment for all brackets except the top 37% bracket.
Enhanced Standard Deduction: Makes the expanded TCJA standard deduction permanent, temporarily boosting the standard deduction by $2,000 for joint filers, $1,500 for head of household, and $1,000 for all other taxpayers from 2025 through the end of 2028.
Child Tax Credit: Increases and adjusts the credit for inflation, benefiting over 40 million families. From 2025 to 2028, the maximum credit temporarily increases to $2,500.
Tax Exemptions: Eliminates federal income tax on tips, overtime pay, and car loan interest for vehicles assembled in the U.S.

Key Business Provisions

Qualified Business Income (QBI) Deduction: Increases the deduction to 23% for pass-through entities.
Interest Expense Limitation: Increases the cap on business interest deductibility by allowing depreciation, amortization, and depletion to be excluded from adjusted taxable income, effective from 2025 to 2029.
Bonus Depreciation: Restores 100% bonus depreciation for qualified property acquired from 2025 through 2029.
Research and Development: Allows immediate expensing of domestic R&D costs from 2025 through 2029.
Excess Business Loss Limitation: Permanently extends the limitation on excess business losses for noncorporate taxpayers, allowing any unused losses to carry forward to the subsequent year. However, the losses will be taken into account in the computation of the excess business loss for that subsequent year.

Additional Measures

SALT Deduction Cap: Permanently raises the state and local tax (SALT) deduction cap to $40,000 with a phased reduction beginning at $250,000 for single filers and $500,000 for joint filers.
Senior Deduction: Adds a $4,000 deduction for seniors (65+) from 2025 to 2028, with income caps of $75,000 (single) and $150,000 (joint).
Border Security and Defense: Allocates significant funding for border enforcement and national defense initiatives.
Social Program Adjustments: Implements stricter work requirements for Medicaid and reduces funding for certain programs.
Estate and Gift Tax: Permanently raises the exemption to $15 million, adjusted for inflation.

Fiscal Considerations
The Congressional Budget Office estimates the bill will increase the federal deficit by $3.8 trillion over the next decade. Market reactions have included concerns over rising Treasury yields and potential impacts on the bond market.

Next Steps
The Senate will now consider the bill, with debates expected on various provisions, including the AI regulation moratorium and social program adjustments. Revisions are likely before any final enactment.

Action Items
If the bills passes in the Senate, taxpayers and business owners should consult with their tax advisors to assess how these proposed changes may impact their financial planning and tax strategies.

This alert is for informational purposes only and does not constitute tax or legal advice. Please consult your CPA or tax advisor for personalized guidance.

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What you need to know before applying for an SBA loan

Posted on May 14, 2025June 2, 2025 by don@mbn.io

May 14, 2025 | by Atherton & Associates, LLP

For many entrepreneurs, an SBA loan is the gateway to launching or acquiring a business—but it’s not as simple as filling out an application. From choosing the right loan type to preparing a lender-ready financial package, success hinges on preparation and financial clarity.

Whether you’re purchasing an existing business or launching a new venture, knowing what to expect can mean the difference between approval and costly delays.

Understanding SBA loan options

The SBA doesn’t lend directly. Instead, it guarantees loans issued by private lenders—such as banks, credit unions, and nonprofit intermediaries—to reduce risk and increase access to capital. Because loans are delivered through these private institutions, terms, underwriting practices, and processing times can vary depending on the lender, the borrower, and the specific loan structure.

What follows is a general overview of some of the most common SBA loan programs. This isn’t an exhaustive list, and it’s important to note that eligibility or documentation requirements may vary depending on your lender or use of funds. All SBA terms and programs are subject to change. Always check with the SBA or your lender for the latest requirements.

Before evaluating which SBA loan might be right for you, make sure your business meets the core eligibility criteria that apply across most SBA loan programs.

Size standards: Your business must qualify as a “small business” based on your industry classification under the North American Industry Classification System (NAICS). The SBA uses your six-digit NAICS code to determine size limits, either by annual revenue or employee count.
Business structure: Your business must be organized for profit and operate in the U.S. or its territories. Nonprofits, certain passive real estate investors, and businesses engaged in illegal activity (even if legal under state law) are ineligible. Franchises and affiliated entities may be eligible but must meet SBA affiliation rules and, in some cases, receive SBA approval.
Credit elsewhere: SBA applicants must show they are unable to obtain credit on reasonable terms without the SBA guarantee. This does not require a formal loan denial, but lenders must certify that comparable financing is not otherwise available under conventional terms.
Repayment ability: Applicants must demonstrate they can repay the loan through business cash flow, have a sound purpose for the loan, and are willing to submit personal and business credit histories—even if the business is newly acquired or recently formed.

With these foundational requirements met, the next step is identifying which SBA loan program aligns with your goals.

SBA 7(a) loans

The SBA 7(a) loan program is the most popular and versatile, used for purposes including business acquisitions, working capital, equipment purchases, debt refinancing, and real estate (when it’s a secondary purpose).

There are several subtypes within the 7(a) umbrella:

Standard 7(a)

The standard 7(a) loan can fund up to $5 million. It’s frequently used for business acquisitions, where borrowers are typically required to provide a 10% equity injection, though lenders may require more depending on experience, risk profile, or collateral.

Lenders are generally required to secure loans over $25,000 in accordance with their internal policies, and loans above $350,000 must be collateralized to the maximum extent possible, though a lack of collateral is not an automatic disqualifier.

Loan terms can extend up to 10 years for working capital or equipment and up to 25 years for real estate components.

The SBA guarantees 85% of the loan amount for loans up to $150,000 and 75% for loans above that. This guarantee protects the lender—not the borrower—but makes financing more accessible.

7(a) small loan

The SBA 7(a) Small Loan program offers financing up to $500,000, with a more automated underwriting process. It’s well-suited for smaller expansions, working capital infusions, or modest acquisitions. While structurally similar to the standard 7(a), it features reduced documentation and faster processing.

SBA express loans

SBA express loans are also capped at $500,000 but offer expedited decisions. The SBA provides a response to the lender within 36 hours, which can speed up – but not guarantee – faster funding decisions. These loans are often used for short-term working capital, equipment purchases, or revolving lines of credit, which can have terms of up to 10 years. The trade-off is that the SBA guarantees only 50% of the loan, which may result in more conservative underwriting or higher interest rates.

SBA 504 Loans

If you’re purchasing real estate or major equipment, an SBA 504 loan may offer more favorable terms than a 7(a). This loan is structured in three parts: a private lender covers 50%, a Certified Development Company (CDC) provides 40%, and the borrower contributes 10%. For startups or special-use properties (e.g., hotels, gas stations), the borrower’s contribution may increase to 15–20%.

504 loans can only be used for fixed asset investments—such as buying or renovating owner-occupied real estate or purchasing long-life equipment. They cannot be used for working capital, inventory, or debt refinancing. Terms are typically 10, 20, or 25 years, with fixed interest rates on the CDC portion.

To qualify, the borrower must occupy at least 51% of an existing building (or 60% of a new construction project), with plans to occupy 80% over time. Passive real estate investment is not allowed.

SBA Microloans

The SBA Microloan program is designed for startups and very small businesses that may not qualify for larger financing. Loans are capped at $50,000, with the average loan amount around $15,000. They are administered by nonprofit, community-based lenders that receive SBA funding and set their own underwriting criteria. These lenders often serve specific regions or business populations.

Funds can be used for working capital, inventory, equipment, or basic startup expenses—but not for real estate purchases or refinancing. Terms are up to six years, and most lenders require a personal guarantee, some collateral, and a detailed plan for use of funds. Because underwriting is handled locally, requirements may vary between intermediaries.

Can you combine or layer SBA loan types?

In some cases, combining SBA loan types can be a strategic way to match your financing structure to your business goals – particularly if you’re acquiring both a business and the real estate it occupies. However, some lenders may not be willing or able to process concurrent SBA loans, so early coordination is crucial.

For example, if your project totals $2.8 million, with $1.8 million for real estate and $1 million for the business acquisition and working capital, you might use a 504 loan for the property and a 7(a) loan for the business. This allows you to leverage the long-term, fixed-rate terms of the 504 loan for the real estate and the flexibility of the 7(a) loan for inventory, goodwill, and staff-related costs.

Collateral is typically aligned with the loan structure—real estate secures the 504 loan, while business assets and a personal guarantee secure the 7(a).

Keep in mind that combining loans increases the importance of repayment capacity. Lenders will assess your Debt Service Coverage Ratio (DSCR), and a minimum of 1.25 is generally required—meaning the business should generate 25% more in annual cash flow than its combined loan payments.

Also, the total SBA 7(a) loan amount is capped at $5 million. The SBA guarantee can cover up to 75-85% of that, meaning the maximum guaranteed portion is $3.75 million for larger loans.

Key documentation lenders expect

Applying for an SBA loan requires a thorough, well-organized financial package. Here’s what lenders will typically request:

A well-crafted business plan – lenders want to understand how your business will operate, make money, and why it’s positioned for long-term success.
Tax returns – typically three years of personal and business tax returns.
Personal Financial Statement (SBA Form 413) – this document lists all of your assets, liabilities, income, and obligations. It’s typically required for all owners with 20% or more equity.
Business Financial Statements – for acquisitions of existing businesses, expect to provide the last three years of profit and loss statements, balance sheets, and cash flow statements. Lenders will generally look for a DSCR of 1.25 or higher.
A Current Debt Schedule – a breakdown of all outstanding business debts, including payment amounts, terms, and remaining balances.
Loan Application Form (SBA Form 1919) – covers basic information about your ownership structure, affiliates, existing debt, and legal history. This is also generally required for all owners with 20% or more equity.

If you’re buying an existing business, lenders may also request a copy of your purchase agreement or letter of intent, a formal valuation or appraisal, and historical financials and tax returns from the seller.

Due diligence matters

One of the most common reasons SBA loan applications stall—or fail altogether—is incomplete, inconsistent, or poorly prepared documentation. Many borrowers underestimate just how rigorous the review process can be.

A CPA can help structure your loan package in a way that speaks directly to lender expectations. For example, a Quality of Earnings (QoE) review can help confirm that a business’s reported earnings are not only accurate but also sustainable.

Similarly, cash flow projections are critical—especially for startups or businesses undergoing a transition. Lenders typically want to see 12 to 24 months of forecasts that are grounded in realistic assumptions.

And pre-due diligence reviews can uncover financial risks that might otherwise derail a deal. Whether it’s inconsistencies in seller financials, unexplained liabilities, or customer concentration issues, identifying these risks early gives borrowers the opportunity to renegotiate deal terms—or walk away from a transaction that may not be as solid as it seems.

Preparation is a strategy

An SBA loan isn’t just a form to fill out—it’s a comprehensive process that rewards preparation, transparency, and credibility. A CPA can help anticipate lender concerns, ensure you have the right documentation, and increase your chances for funding success.

If you’re planning to start or buy a business, don’t wait until after your loan application is submitted to get expert support. Reach out for more personalized guidance.

Let’s Talk!

Call us at (209) 577-4800 or fill out the form below and we’ll contact you to discuss your specific situation.

1031 Exchanges: what qualifies and where investors get tripped up

Posted on April 1, 2025April 1, 2025 by don@mbn.io

April 01, 2025 | by Atherton & Associates, LLP

If you’re thinking about selling investment real estate, you’ve probably heard someone say, “Just do a 1031 exchange—you won’t pay any tax.” That’s partially accurate but also an oversimplification.

The IRS does allow you to defer capital gains taxes on the sale of certain property, but the rules around Section 1031 exchanges are a bit more nuanced than most people realize. And getting it wrong—especially on what qualifies—can result in unexpected tax liability.

What is a 1031 exchange?

In short, a 1031 exchange lets you sell one piece of investment or business-use real estate and defer the capital gains taxes by rolling the proceeds into another qualifying property. It’s named after Section 1031 of the Internal Revenue Code, and it’s been around in some form for over 100 years.

The key concept here is “like-kind.” You’re exchanging one like-kind property for another.

Importantly, the IRS requires that a third-party intermediary facilitate the exchange process. This entity is called a qualified intermediary (QI), and it plays a role in nearly all exchanges.

What types of property qualify?

Under current law, only real property qualifies for a 1031 exchange. That’s a change from pre-2018 rules—before then, certain personal property (like equipment or aircraft) could be exchanged, too. The Tax Cuts and Jobs Act (TCJA) narrowed it to real estate only (IRC §1031(a)(1)).

Now, eligible real property can include:

Commercial buildings
Rental properties (residential or mixed-use)
Raw land
Industrial facilities
Retail centers
Oil, gas, and mineral interests, in certain circumstances

Even long-term leasehold interests (typically 30 years or more) may qualify in some cases.

It’s also worth noting: the properties don’t have to be the same type. You can exchange raw land for an apartment complex or a strip mall for a warehouse. As long as both are held for investment or business use, the IRS generally treats them as like-kind (Treas. Reg. §1.1031(a)-1(b)).

What doesn’t qualify?

Several categories of property are ineligible for 1031 treatment. These include:

Property held primarily for resale (think fix-and-flip properties or land held for development and quick turnover)
Primary residences
Second homes or vacation homes, unless they meet strict rental and use requirements
Foreign property (U.S. property must be exchanged for U.S. property only)

Additionally, personal-use items such as vehicles, equipment, or artwork are excluded from eligibility under the current rules, regardless of how they are used in a business context.

Vacation rentals: a common gray area

Vacation homes used for both rental and personal purposes can fall into a gray area. The IRS has provided a safe harbor under Revenue Procedure 2008-16 that allows some vacation rentals to qualify, but strict requirements apply:

The property must be rented for at least 14 days per year;
Personal use must be limited to 14 days or 10% of the rental days, whichever is greater;
The taxpayer must meet these criteria for at least two years before and after the exchange.

If these thresholds aren’t met, the property is unlikely to qualify under 1031 rules.

Timing rules

Even if your properties qualify, the timeline rules are strict:

You have 45 days from the sale of your relinquished property to identify a replacement property.
You have 180 days to close on the replacement.

And yes, these timelines run concurrently. Day 180 doesn’t reset after Day 45—it’s all from the date of the first sale.

If either deadline is missed, the exchange fails, and the gain becomes taxable.

Intent matters

Although not explicitly stated in the statute, intent is a critical factor. The IRS and courts often evaluate whether the property was truly acquired for investment or business use.

For instance, if a taxpayer acquires a replacement property and sells it within a few months, the IRS may challenge the exchange based on a lack of investment intent. Similarly, attempting to exchange into a personal residence may raise concerns unless the property is held as a rental for a significant period first.

There’s no statutory holding period, but retaining the replacement property for at least one year is generally considered a prudent guideline.

The role of the qualified intermediary

Many taxpayers are surprised to learn that they cannot take direct possession of the sale proceeds in a 1031 exchange—not even temporarily. If you receive the funds, even for a day, the IRS considers the exchange invalid, and the gain becomes taxable.

That’s where the qualified intermediary comes in.

A QI—sometimes referred to as an exchange accommodator or facilitator—holds the proceeds from the sale of your relinquished property in escrow until they are used to purchase the replacement property. The QI may also prepare the necessary exchange documentation, ensure compliance with IRS regulations, and help manage the strict timeline requirements.

Why is a QI necessary?

Because IRS rules explicitly prohibit the taxpayer from having constructive receipt of the funds. Even if you never deposit the check, routing the proceeds through your own attorney or escrow agent can disqualify the exchange if not structured properly.

Clients often ask why this intermediary is necessary and why it comes with an out-of-pocket cost. The reality is that the QI is not just a formality—it’s a critical safeguard in keeping the exchange compliant. While fees vary, the cost is generally modest relative to the tax deferral benefit.

Advanced exchange options

Sometimes, your situation just doesn’t line up neatly with the typical 1031 exchange timeline or structure. Fortunately, there are more flexible options—but they come with extra complexity.

Reverse exchanges: buy first, sell later

In a standard exchange, the relinquished property is sold first. But what happens if you identify the ideal replacement property before you’ve finalized the sale?

That’s where a reverse exchange becomes useful. In this structure, a qualified intermediary—through an Exchange Accommodation Titleholder (EAT)—temporarily holds title to either the relinquished or replacement property during the transaction.

The 45-day and 180-day deadlines still apply, but in reverse sequence. This allows more flexibility in timing, but adds cost and complexity. Financing can also be more challenging, since the EAT holds legal title to the property during part of the exchange process.

Still, it’s a valuable tool when market timing doesn’t cooperate.

Build-to-suit exchanges: customize your replacement property

If the replacement property requires significant renovation—or if you intend to build on undeveloped land—you might consider a build-to-suit exchange, also known as an improvement exchange.

This structure allows exchange proceeds to be used for construction or renovation before the taxpayer takes legal title. Again, the intermediary (via an EAT) holds title during the build-out phase.

However, all improvements must be completed within the 180-day exchange window, and ownership must be formally transferred to the taxpayer within that period. If improvements are incomplete, only the value of what’s been completed by day 180 can be counted toward deferral.

These exchanges take careful planning and close coordination between your CPA, your intermediary, and your builder.

Laddering exchanges: long-term planning for real estate investors

Many experienced investors use laddering as a long-term strategy. Essentially, you start with one property, exchange into a larger or better-performing one, then do it again. And again. Each time, you defer the gain and build more equity.

Eventually, you may decide to cash out and recognize the gain (hopefully in a lower-tax year). Or, you may hold the final property until death—in which case your heirs get a step-up in basis, and the deferred gain essentially disappears.

It’s a long-game strategy, but it’s one that many successful investors use to build wealth and reduce taxes along the way.

A 1031 exchange can be a powerful tax strategy—if you get the details right

A well-structured exchange can preserve capital and open the door to better investment opportunities. But it’s not a DIY strategy. The rules around property type, timing, and use all require careful execution.

If you’re considering a sale or contemplating a new investment, we strongly recommend discussing your options with a tax advisor early in the process. We can help you weigh your options, identify potential roadblocks, and structure the exchange in a way that actually works.

For personalized guidance, please contact our office.

Let’s Talk!

Call us at (209) 577-4800 or fill out the form below and we’ll contact you to discuss your specific situation.

The Pros and Cons of Different Business Entities: A Comprehensive Guide

Posted on November 26, 2024March 31, 2026 by don@mbn.io

November 26, 2024 | by Atherton & Associates, LLP

The Pros and Cons of Different Business Entities: A Comprehensive Guide

Choosing the right business structure is one of the most critical decisions entrepreneurs and business owners face. The entity you select will have profound implications on how your business operates, how it is taxed, your personal liability, and your ability to raise capital. With several options available, each with its own advantages and drawbacks, making an informed choice requires careful consideration.

In this comprehensive guide, we’ll explore the various types of business entities, dissecting their pros and cons to help you determine which structure aligns best with your business goals and needs.

Factors to Consider When Choosing a Business Entity

Before diving into the specifics of each business entity, it’s essential to understand the key factors that should influence your decision:

Liability Protection: The extent to which your personal assets are protected from business liabilities.
Tax Implications: How the business and its owners are taxed, including opportunities for tax savings or risks of double taxation.
Management and Control: Who will manage the business, and how decisions will be made.
Administrative Requirements: The complexity and cost of forming and maintaining the entity, including paperwork and compliance obligations.
Capital Raising: The entity’s ability to attract investors and raise funds for growth.
Flexibility: How easily the business can adapt to changes in ownership, management, or strategic direction.
Future Needs: Long-term goals such as expansion, succession planning, or going public.

Overview of Different Business Entities

Sole Proprietorship

A sole proprietorship is the simplest form of business entity, where an individual operates a business without forming a separate legal entity. It’s an attractive option for solo entrepreneurs starting small businesses.

Pros

Easy and Inexpensive to Establish: Minimal legal paperwork and costs are required to start operating.
Complete Control: As the sole owner, you make all decisions and have full control over the business.
Simplified Tax Filing: Business income and losses are reported on your personal tax return, eliminating the need for a separate business return.

Cons

Unlimited Personal Liability: You’re personally responsible for all business debts and obligations, putting personal assets like your home at risk.
Difficulty Raising Capital: Investors and lenders may be hesitant to finance sole proprietorships due to perceived higher risk.
Lack of Continuity: The business may cease to exist upon the owner’s death or decision to stop operating.
Limited Tax Deductions: Certain business expenses deductible by corporations may not be available to sole proprietors.

While a sole proprietorship offers simplicity and control, the trade-off is significant personal risk and potential challenges in growing the business beyond a certain point.

Partnerships

Partnerships involve two or more individuals (or entities) joining to conduct business. They share profits, losses, and management responsibilities. There are different types of partnerships, each with unique characteristics.

General Partnership

In a general partnership, all partners share management duties and are personally liable for business debts and obligations.

Pros

Combined Expertise and Resources: Partners can pool skills, knowledge, and capital, enhancing the business’s potential.
Pass-Through Taxation: Profits and losses pass through to partners’ personal tax returns, avoiding corporate taxes.
Relatively Easy Formation: Establishing a general partnership typically requires a partnership agreement but involves fewer formalities than corporations.

Cons

Unlimited Personal Liability: Each partner is personally liable for the business’s debts and the actions of other partners.
Potential for Disputes: Differences in vision or management style can lead to conflicts affecting the business.
Lack of Continuity: The partnership may dissolve if a partner leaves or passes away unless otherwise stipulated in the agreement.
Difficulty Attracting Investors: Investors may prefer entities that offer ownership shares and limit liability.

Limited Partnership (LP)

An LP includes general and limited partners. General partners manage the business and have unlimited liability, while limited partners contribute capital and have liability limited to their investment.

Pros

Liability Protection for Limited Partners: Limited partners’ personal assets are protected beyond their investment amount.
Attracting Passive Investors: The structure is appealing to investors seeking to invest without involving themselves in management.
Pass-Through Taxation: Similar to general partnerships, avoiding double taxation.

Cons

Unlimited Liability for General Partners: General partners remain personally liable for business debts and obligations.
Complex Formation and Compliance: LPs require formal agreements and adherence to state regulations, increasing administrative burdens.
Limited Control for Limited Partners: Limited partners risk losing liability protection if they take an active role in management.

Limited Liability Partnership (LLP)

An LLP offers all partners limited personal liability, protecting them from certain debts and obligations of the partnership and actions of other partners. It’s often used by professional service firms like law and accounting practices.

Pros

Limited Personal Liability: Partners are typically not personally liable for malpractice of other partners.
Flexible Management Structure: All partners can participate in management without increasing personal liability.
Pass-Through Taxation: Business income passes through to personal tax returns.

Cons

State Law Variations: LLP regulations differ significantly by state, affecting liability protections and formation processes.
Potential Restrictions: Some states limit LLPs to certain professions or business types.
Administrative Complexity: LLPs may have additional filing and reporting requirements.

Partnerships offer the benefit of shared responsibilities and resources but come with risks related to personal liability and potential internal conflicts.

Corporations

Corporations are independent legal entities separate from their owners (shareholders), offering robust liability protection and the ability to raise capital through the sale of stock.

C Corporations

A C corporation is the standard corporation under IRS rules, subject to corporate income tax. It’s suitable for businesses that plan to reinvest profits or seek significant outside investment.

Pros

Strong Liability Protection: Shareholders are not personally liable for corporate debts and obligations.
Unlimited Growth Potential: Ability to issue multiple classes of stock and attract unlimited investors.
Deductible Business Expenses: C corporations can deduct the full cost of employee benefits and other expenses not available to other entities.
Perpetual Existence: The corporation continues to exist despite changes in ownership.

Cons

Double Taxation: Corporate profits are taxed at the corporate level, and dividends are taxed again on shareholders’ personal tax returns.
Complex Formation and Compliance: Incorporation requires significant paperwork, ongoing record-keeping, and adherence to formalities.
Higher Costs: Legal fees, state filing fees, and ongoing compliance expenses can be substantial.

S Corporations

An S corporation is a corporation that elects to pass corporate income, losses, deductions, and credits through to shareholders for federal tax purposes, thus avoiding double taxation.

Pros

Pass-Through Taxation: Profits and losses pass through to shareholders, preventing double taxation.
Liability Protection: Similar to C corporations, personal assets are generally protected from business liabilities.
Attractive to Investors: Offers the credibility of a corporate structure, which can be appealing to some investors.

Cons

Strict Eligibility Requirements: Limited to 100 shareholders who must be U.S. citizens or residents; can only issue one class of stock.
Limited Deductible Benefits: Certain employee benefits are not fully deductible for shareholders owning more than 2% of the company.
Administrative Responsibilities: Must adhere to corporate formalities like holding annual meetings and maintaining records.

Corporations offer significant advantages in liability protection and capital raising but come with increased complexity and potential tax disadvantages.

Limited Liability Company (LLC)

An LLC combines the liability protection of a corporation with the tax efficiencies and operational flexibility of a partnership. It’s a popular choice for many businesses due to its adaptability.

Pros

Limited Liability Protection: Members are generally shielded from personal liability for business debts and claims.
Flexible Tax Treatment: Can choose to be taxed as a sole proprietorship, partnership, S corporation, or C corporation, offering potential tax advantages.
Flexible Management Structure: Can be member-managed or manager-managed, providing options for how the business is run.
Less Compliance Paperwork: Fewer formal requirements compared to corporations, though an operating agreement is highly recommended.

Cons

Varied Treatment by State: LLC laws and fees vary by state, possibly affecting profitability and operations.
Self-Employment Taxes: Members may be subject to self-employment taxes on their share of profits, potentially increasing tax burdens.
Investor Reluctance: Some investors may prefer corporations due to familiarity and ease of transferring shares.
Complexity in Multi-State Operations: Operating in multiple states can complicate tax and regulatory compliance.

The LLC offers a balance of flexibility and protection, making it suitable for many businesses, though it’s essential to understand specific state laws and tax implications.

Comparing Business Entities

Taxation Differences

The way a business entity is taxed can significantly impact its profitability and the owner’s personal tax burden.

Sole Proprietorships and Partnerships: Income and losses pass through to owners’ personal tax returns, and taxes are paid at individual rates.
C Corporations: Subject to corporate tax rates, with potential double taxation when profits are distributed as dividends.
S Corporations and LLCs: Generally enjoy pass-through taxation, avoiding double taxation, but with specific eligibility requirements (S corporations).

Liability Protection

Sole Proprietorships and General Partnerships: Owners have unlimited personal liability for business debts and obligations.
Limited Partnerships: Limited partners have liability protection, but general partners do not.
LLPs, LLCs, and Corporations: Offer varying degrees of liability protection, generally shielding personal assets from business liabilities.

Management and Control

Sole Proprietorships: The owner has total control over decisions and operations.
Partnerships: Management is shared among partners; roles should be defined in a partnership agreement.
Corporations: Managed by a board of directors and officers; shareholders have limited direct control.
LLCs: Offer flexibility; management can be structured to fit the owners’ preferences.

Administrative Requirements and Costs

Sole Proprietorships and General Partnerships: Minimal setup costs and ongoing formalities.
Limited Partnerships and LLPs: Require formal agreements and state registrations, increasing complexity and costs.
Corporations: Higher formation costs and ongoing compliance obligations, including annual reports and meetings.
LLCs: Moderate costs; while less formal than corporations, they still require an operating agreement and may have state filing requirements.

Choosing the Best Form of Ownership for Your Business

Determining the optimal business entity involves evaluating your specific situation against the characteristics of each entity type.

Consider the following steps:

Assess Your Liability Exposure: If your business involves significant risk, entities offering liability protection may be more suitable.
Evaluate Tax Implications: Consult with a tax professional to understand how each entity will impact your tax obligations.
Consider Management Structure: Decide how you want the business to be managed and the level of control you wish to maintain or share.
Plan for Capital Needs: If raising capital is a priority, structures like corporations may offer advantages in attracting investors.
Reflect on Future Goals: Your long-term objectives, such as expansion or succession planning, should align with the entity’s capabilities.
Understand Compliance Requirements: Be prepared for the administrative responsibilities associated with more complex entities.

Remember, there’s no one-size-fits-all answer. Your business’s unique needs and your personal preferences will guide the best choice. Furthermore, as your business grows and evolves, you may need to reevaluate your entity choice.

How Atherton & Associates LLP Can Help

Navigating the complexities of choosing the right business entity is challenging, but you don’t have to do it alone. Atherton & Associates LLP offers comprehensive tax and advisory services to guide you through this critical decision-making process.

Tax Compliance & Planning

Our team assists businesses and individuals in staying compliant with tax laws and regulations. We provide strategic tax planning to help minimize liabilities and maximize potential savings, all while ensuring adherence to ever-changing tax laws.

Entity Choice Consultation

We provide personalized guidance in selecting the most suitable business entity. By analyzing your unique business situation, goals, and potential risks, we suggest the most beneficial entity type—be it a sole proprietorship, partnership, corporation, or LLC.

Estate & Trust Planning

Protecting your assets and planning for the future are paramount. Our specialized estate and trust planning services aim to reduce the potential tax impact on your beneficiaries. We work closely with you to develop a comprehensive plan that aligns with your financial goals, ensuring a seamless transition of wealth to the next generation.

With Atherton & Associates LLP, you’re partnering with experienced professionals dedicated to your business’s success. Our expertise spans various industries, including agriculture, real estate, construction, retail manufacturing, and distribution services. We understand that each client is unique, and we’re committed to providing tailored solutions that meet your specific needs.

Conclusion

Selecting the right business entity is a foundational step that affects every aspect of your business, from daily operations to long-term growth. By thoroughly understanding the pros and cons of each entity type and considering your individual circumstances and goals, you can make an informed decision that positions your business for success.

At Atherton & Associates LLP, we’re here to support you through this process, offering expert advice and services that help you navigate the complexities of business ownership. Whether you’re just starting or looking to reassess your current structure, our team is ready to assist in charting the best path forward for your business.

Contributors

Jackie Howell, Tax Partner

Email: jhowell@athertoncpas.com

Jackie Howell has been in public accounting since 2010, with a concentration in tax compliance and planning for individuals, privately held corporations, partnerships, non-profit organizations, and multi-state taxation. Her unique skill set allows her to assist clients across a broad range of industries, including agriculture, real estate, construction, retail manufacturing, and distribution services.

Natalya Mann, Tax Partner

Email: nmann@athertoncpas.com

Natalya Mann brings seventeen years of experience as a Certified Public Accountant and business advisor. She specializes in tax compliance, tax planning, business consulting, and strategizing the best solutions for her individual and business clients. Natalya collaborates with clients in healthcare, professional services, real estate, manufacturing, transportation, retail, and agriculture industries.

Craig Schaurer, Tax Partner, Managing Partner

Email: cschaurer@athertoncpas.com

With a career in public accounting since 2006, Craig Schaurer focuses on tax compliance and planning for the agricultural industry, including the entire supply chain from land-owning farmers to commodity processing and distribution. His expertise encompasses entity and individual tax compliance, specialty taxation of Interest Charged Domestic International Sales Corporations (IC-DISCs), and cooperative taxation and consultation.

Rebecca Terpstra, Tax Partner

Email: rterpstra@athertoncpas.com

Rebecca Terpstra specializes in tax planning, consulting, and preparation for individuals and all business entities. She has extensive experience working with large corporations and high-net-worth individuals across various industries, including agriculture, manufacturing, telecommunications, real estate, financial institutions, retail, and healthcare.

Michael Wyatt, Tax Manager

Email: mwyatt@athertoncpas.com

Michael Wyatt has been serving in public accounting since 2019. He specializes in corporate, partnership, and individual taxation, as well as tax planning. Michael provides tax services for clients in the agricultural, real estate, and service industries. He has experience with estate and business succession planning and multi-state taxation, assisting clients through complex transactions.

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