Wise Cat Series: LLC, C-Corp, or S-Corp: Which Entity Do You Select?

Dec. 29, 2017

 

C Corporation

S Corporation

LLC

Formation Requirements

File Articles of Incorporation with Secretary of State.

File Articles of Incorporation with Secretary of State.

File Articles of Organization with Secretary of State.

Other Documents to Consider at Formation

·     Federal and state tax ID Nos.

·     Bylaws.

 

·    File S-election on Form 2553 with the IRS within 2 ½ months.

 

·    Federal and state tax ID Nos.

·  Operating Agreement.

 

Liability of Owners

No personal liability for the corporation’s debts to the extent of investment.  No personal liability for the acts or omissions, including negligence, of other shareholders or employees of the corporation.

No personal liability for the corporation’s debts to the extent of investment.  No personal liability for the acts or omissions, including negligence, of other shareholders or employees of the corporation.

No personal liability for the company’s debts beyond the extent of investment.  No personal liability for the acts or omissions, including negligence, of other members or employees of the LLC.

Number of Owners

1 or more shareholders.

1-100 shareholders.

1 or more members (but with one member, a single-member LLC).

Types of Owners

Any.

No entities. No nonresident aliens, or certain trusts.  Exempt owners must be persons, residents, certain grantor trusts, S corporations or exempt organizations.

Any.

Classes of Ownership Interests

Multiple Classes Permitted

One Class (with certain exceptions; voting/nonvoting allowed).

Multiple Classes Permitted

Taxation

Corporate level – taxable income.

Shareholder level – dividends.

Shareholder level tax only; Pro rata share of income, whether distributed or not.

Allocable share of income, whether distributed or not.

Tax on Formation

No gain or loss if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control of the corporation.  Stock for services is taxable to the shareholder.

No gain or loss is recognized if property is transferred to a corporation by one or more persons solely in exchange for stock in such corporation and immediately after the exchange such person or persons are in control of the corporation.  Stock for services is taxable to the shareholder.

Generally, no gain or loss is recognized if property is transferred to an LLC for membership interests.  Membership interests for services are taxable to the member.

Liabilities Contributed to Entity

Basis in stock does not include any amount of corporation’s direct debt.

Basis in stock does not include any amount of corporation’s direct debt; if shareholder loans money to corporation, additional basis for shareholders.

Member’s membership interest includes not only property contributed, but also member’s share of liabilities (a member’s basis determines the amount of money and losses that may be distributed to the member without tax).

Shifting of Gain on Contributed Property

N/A.

Built-in gain or loss in property contributed to S corporation shares among all S corporation shareholders.

Built-in gain or loss attributable to the contributed property as of the contribution date is allocated to a contributing member.

Tax Returns/Tax & Accounting Complexity

Files separate tax return (IRS Form 1120).

Accounting is not complex.

 

Files separate tax return (IRS Form 1120S), but return is only an information tax return, no corporate level tax, Schedule K-1 issued to shareholders.

Accounting is not complex.

Files Partnership tax return (IRS Form 1065), but return is only an information tax return; no LLC/LP level tax, Schedule K-1 issued to shareholders.

Accounting can be complex.

Dividends/

Distributions

Dividends pro rata per class

Distributions pro rata per stock ownership (1 class of stock only).

Special allocations permitted (i.e., non-pro rata), but allocations must have substantial economic effect for tax purposes.

Restricted Equity Interests for Services

Section 83 allows the taxpayer who receives restricted stock to elect to include the value of the restricted stock in gross income in the year of receipt

Section 83 allows the taxpayer who receives restricted stock to elect to include the value of the restricted stock in gross income in the year of receipt

Service providers can receive certain tax treatment for unvested or restricted profits interests in LLCs in exchange for services (Rev. Proc. 93-27 and Rev. Proc. 2001-43)

Owners as Managers/

Officers

Permitted

Permitted

Permitted, but self-employment tax issues.

Losses

N/A

Shareholder cannot deduct losses in excess of basis in stock and debt; subject to at-risk and passive loss rules

Member or Partner may deduct losses subject to member’s basis in membership interest and at-risk for its passive loss rules

Fringe Benefits

May deduct cost of providing fringe benefits to all employees.  Fringe benefit plan must meet certain federal and state law requirements

May deduct as a business expense only amounts of fringe benefits that it pays to shareholder employees who own 2% or less of its stock.  Shareholder employees who own more than 2% of stock will have such payments treated as taxable compensation

If member or partner is “self-employed,” not entitled to tax favored treatment for employee benefits; benefits taxed as guaranteed payments; may be deductible by self-employed person.

Permits contributions to Self Employed 401(k), Simplified EE Pension (SEP) IRA, or Savings Incentive Match Plan for Employees (SIMPLE) 401(k)

Liquidation

Distributions must be proportionate to stock ownership in a class.  Tax at corporate and shareholder level unless 80% corporate shareholder

Distributions pro rata in accordance with stock ownership.  Shareholder taxable on appreciation and value of S corporation

Distributions in accordance with positive capital account balances non-taxable unless certain items received in excess of adjusted basis of membership interest

Mergers

Tax-free reorganization provisions apply.  See IRC § 368.  Provided statutory, regulatory, and case law requirements are satisfied, corporation may, in a tax-free or partially tax-free manner, acquire stock or assets of another corporation

 

Tax-free reorganization provisions do not apply.  See IRC § 368; Treasury Regulations § 1.708-1 (partners could recognize gain on the sale of a partnership interest in a merger or consolidation of two partnerships by an election treating the merger or consolidation as a sale of a partnership interest)

 

 

 


Written By:
Kimberly Lowe

For almost 20 years Kim Lowe has lawyered from the trenches. Kim lawyers from experience, using her knowledge of the law and understanding of how both for-profit and nonprofit business enterprises operate.

E-mail Kimberly

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