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Forming a Business

Selecting the right entity at the outset of a business establishment will determine the consequences of the tax implications of operating and generating revenue. Depending on which entity is chosen, there may be several tax advantages and liabilities associated with an entity.

i) There are several types of entities that an entrepreneur can form based on their intended purpose:

  • C Corporation
  • S Corporation
  • Partnership
  • Limited Liability Company
  • Limited Liability Partnership
  • Business Trust
  • Sole Proprietorship

ii) Choice of Entity Chart describing basic structure, tax implications, and liabilities.

Basic Structure:

General Issues / Liabilities C Corp. S Corp. Partnership LLC Business Trust Sole Proprietorship
Limited Liability Yes Yes Unlimited liability for general partners. Limited Liability for limited partners, unless limited partner lose the shield by acting similar to a general partner involved in management Yes Yes, generally the same as a director of a sharehold in a corporation Unlimited liability
Number of Owners No restriction Max. 100 At least 2 at least 2, unless a "disregarded entity" for tax purposes At least 2, unless a "disregarded entity" for tax purposes Only 1
Type of Owners No limitations No corporation, LLC, partnerships, or nonresident aliens, or certain trust except that another S corporation can be an owner. No limitation No limitations, nonresident alien can be a owner No limitations Individuals only and trusts.
Owners having different economic classes of ownership Yes No, but owners can have different voting rights. Yes Yes, Same as partnerships, general member or limited member, and they can be classified and given different roles Yes. Same as partnerships N/A - only 1 owner
Continuity of Life perpetual unless stated otherwise Same as C Corp Depends on majority of remaining partners must agree to continue the partnership if partner or partners disassociate, or it was not for term of life, or for a particular undertaking Yes, if the operating agreement provides that the LLC is not dissolved following a member's cessation, or for not a certain period of time. Yes No
Centralized Management Yes Yes No for general partnership; usually yes for limtied partnership Depends, the LLC may have a structure based on member managed or manager-managed models Yes, unless otherwise provided in the governing instrument, trustees have similar powers and responibilities as directors in a corporation. N/A - only 1 owner
Degree of administrative complexity Moderate High Moderate; depending on complexity of partnership agreement and special allocation of distributino and voting rights Moderate and same as partnership depending on the structure High Low

Tax Implications:

Tax Implications C Corp. S Corp. Partnership LLC Business Trust Sole Proprietorship
Tax on contribution of property Taxable unless transferors meet an 80% control test. Subject to diversification limitation Same as C Corp Generally nontaxable unless "disguised sale." Subject to diversification limitations Same as Parntership Same as Partnership N/A
Double taxation Yes No, unless too much pasive income or built-in gains No No No NO
Maximum marginal federal tax rate for 2010 35% 25% on built-in gain and excess passive income if formerly a C corp 25% at parnter level Same as Parntership for a member 25% at beneficial owner level 35%
Ability to retain income at lower current tax cost First $100,000 may be subject to lower rates No No No No No.
Taxation of cash distribution Taxation on divident to extent of Earnings; then non-taxable to extent of basis Non taxable to extent of basis Non-taxable to extent of basis in partnership interest Non-taxable to extent of basis in LLC interest Non taxable to extent of basis in trust units N/A
Taxation of Property distribution Depends on the property, it may be taxable to both the corporation and shareholder Depends on appreciation, corporation may pay tax, but shareholder may not Depends on whether it is an "unequal distrubtion" of "hot assets" Similar to Partnership Similar to Partnership N/A
Self-employment tax on distributive share of income N/A Generally no but may be a problem if unreasonable low compensation. Law changes in 2013 and high income taxpayers who will be taxed on passive income Yes for general partners. Implications of 2013 law changes to passive income No clear for LLC members. Change of law in 2013 will have implications Similar implications of law changes in 2013.

Liabilities:

Tax Implications C Corp. S Corp. Partnership LLC Business Trust Sole-Proprietorship
Tax on contribution of property Taxable unless transferors meet an 80% control test. Subject to diversification limitation Same as C Corp Generally nontaxable unless "disguised sale." Subject to diversification limitations Same as Parntership Same as Partnership N/A
Double taxation Yes No, unless too much pasive income or built-in gains No No No NO
Maximum marginal federal tax rate for 2010 35% 25% on built-in gain and excess passive income if formerly a C corp 25% at parnter level Same as Parntership for a member 25% at beneficial owner level 35%
Ability to retain income at lower current tax cost First $100,000 may be subject to lower rates No No No No No.
Taxation of cash distribution Taxation on divident to extent of Earnings; then non-taxable to extent of basis Non taxable to extent of basis Non-taxable to extent of basis in partnership interest Non-taxable to extent of basis in LLC interest Non taxable to extent of basis in trust units N/A
Taxation of Property distribution Depends on the property, it may be taxable to both the corporation and shareholder Depends on appreciation, corporation may pay tax, but shareholder may not Depends on whether it is an "unequal distrubtion" of "hot assets" Similar to Partnership Similar to Partnership N/A
Self-employment tax on distributive share of income N/A Generally no but may be a problem if unreasonable low compensation. Law changes in 2013 and high income taxpayers who will be taxed on passive income Yes for general partners. Implications of 2013 law changes to passive income No clear for LLC members. Change of law in 2013 will have implications