Comparison of Entity Choices

Transcription

1 Comparison of Entity Choices The following table illustrates the major differences in operating a business as a C corporation, S corporation, partnership,, or sole proprietorship. PPC's Tax Planning Guide S Corporations, PPC's Tax Planning Guide Closely Held Corporations, PPC's Tax Planning Guide Partnerships, PPC's Guide to Limited Liability Companies, and PPC's Guide to Tax Planning for High Income Individuals address the planning opportunities, issues, and problems of operating each type of business. Issue C Corp S Corp Partnership Limited liability for owners? Generally limited to assets in Generally limited to assets in No for general partners; yes for limited partners. Limited partners cannot be actively involved in the business without losing limited liability. Limited liability partnerships (LLP) may either (1) provide partners with protection from vicarious liabilities, or (2) provide complete liability protection, depending on the provisions of the state's LLP Act. No, liability is unlimited. Flexible and capital structure? Limited to 100 shareholders and one class of stock. Types of shareholders limited. Need at least two partners. s with a single member are disregarded for federal taxes. s must have two or more members to be taxed as partnerships. No one owner. Continuity of life for entity? Yes, but stock must be monitored. Generally, no. Depends on state law provisions. Usually. Depends on state law provisions. Ceases on death of proprietor.

2 Terminates for federal taxes if 50% or more of capital and profits interests are transferred during a 12-month period. Terminates for federal taxes if 50% or more of capital and profits interests are transferred during a 12-month period. Centralized management of entity? Managed by board of directors; corporate officers. Managed by board of directors; corporate officers. No for general partnership; usually yes for limited partnership. Limited partners cannot participate in management. Often, yes. Managed by elected or appointed managers. Yes one owner. Free transferability of interests? Yes, but may be contractually limited by a buy/sell agreement. Yes, but must observe limitations on who can own stock. Also may be contractually limited by a buy/sell agreement. Generally, subject to partners' approval. May be limited by buy/sell provisions in partnership agreement or separate agreement. Generally, subject to members' approval. May be limited by buy/sell provisions in partnership agreement or separate agreement. No, but as a practical matter, the entire business may be sold. Degree of administrative complexity? High. Separate tax return required. Must comply with state requirements. High. Separate tax return required. Must comply with state requirements. Moderate. Separate tax return required. Moderate. Separate tax return required. Meetings may be required. Low. Certainty of legal and tax outcomes? High. High to moderate. Moderate. Moderate. High. Taxation of liquidation? At corporate level, treated as sale of property; distribution to shareholder is taxed as liquidating distribution (capital gain or loss). However, see IRC Sec on qualified small business corps. At corporate level, treated as sale of property; gain passes through and increases shareholder basis; could trigger builtin gains tax if former C Generally, nontaxable; each distribution in excess of basis will trigger gain; Generally, nontaxable; each distribution in excess of basis will trigger gain; Nontaxable. Ability to retain income at lower current tax cost? Tax treatment of fringe benefits for owners? Good. Poor, if own more than 2% of stock. Poor. Poor. Poor. SE tax on owner distributions? But, some risk that distributions Generally, yes, unless partner is a Generally, yes, unless member is

3 will be classified as wages if reasonable wages not paid limited partner. General partners treat their share of partnership ordinary trade or business income as SE income. Guaranteed services or the use of capital (if the partnership is engaged in a trade or business) are also SE income. Limited partners include only guaranteed services as SE income. treated as a limited partner. Members treated as general partners treat their share of ordinary trade or business income as SE income. Guaranteed services or the use of capital (if the is engaged in a trade or business) are also SE income. Members treated as limited partners include only guaranteed services as SE income. Flexibility to select tax year? May select any tax year if not a personal service Limited. Generally must use calendar year or make Section 444 election. Limited. Generally must use tax year of majority interest owners or make Section 444 election. Limited. Generally must use tax year of majority interest owners or make Section 444 election. Must use the year of proprietor. Passive loss rules apply? No, unless a PSC or closely held corp. Yes at shareholder Yes at partner Treatment of limited partners is unfavorable. Yes at member level; members may be able to avoid limited partner treatment under proposed regulations. Deduction for corporate dividends received? Favorable tax rate on long-term capital gains? No, regular corporate rates apply. Personal holding company tax applies? Accumulated earnings tax applies? Unreasonable owner compensation issue applies? For unreasonably high compensation. Yes, for unreasonably low compensation.

4 Personal service corporation (PSC) rules apply? Limitations on use of cash method? Yes, but smaller corporations and PSCs can use cash method. No, unless the corporation maintains inventories or is a tax shelter. (However, if a gross receipts test is met, the cash No, unless the partnership has a C corporation partner, maintains inventories, or is a tax shelter. (However, if a gross receipts test is met, the cash No, unless the has a C corporation member, maintains inventories, or is a tax shelter. (However, if a gross receipts test is met, the cash No, unless the proprietorship maintains inventories. (However, if a gross receipts test is met, the cash Limitations on use of NOLs and other tax attributes after change? N/A. Losses pass through to owners. Limits apply at shareholder N/A. Losses pass through to owners. Limits apply at partner N/A. Losses pass through to owners. Limits apply at member Losses offset individual's income subject to certain restrictions. Entity-level AMT? Yes, but smaller corporations are excepted. information must be provided to shareholders. information must be provided to partners. information must be provided to members. information can affect owner's AMT calculation. Potential ability to reduce payroll taxes of owneremployees? Yes, within limits of reasonableness. No, but may benefit from employing owner's children under age 18. No, but may benefit from employing owner's children under age 18. No, but may benefit from employing owner's children under age 18. Potential favorable treatment of owner-level interest expense on debt to inject capital or acquire Double taxation at state and local tax level? Generally, yes. Sometimes. Rarely. Rarely. Additional ownerlevel tax basis from entity-level debt (for loss deduction purposes)? Yes, but only for direct loans from shareholders. Yes, but generally not for at-risk purposes. N/A, but owner gets basis from debt since no entity exists. Basis adjustments upon purchase of Mandatory basis adjustments may be required on Mandatory basis adjustments may be required on

5 certain transfers or certain transfers or Flexibility to make tax-free contributions? No, unless Section 351 requirements are met. No, unless Section 351 requirements are met. Generally, yes. However, certain contributions may trigger gain. Generally, yes. However, certain contributions may trigger gain. Flexibility to make tax-free distributions? Distributions are generally taxable dividends. Distribution of appreciated property results in corporate gain. Nontaxable to shareholder to extent of basis; appreciated property results in corporate gain. Nontaxable to extent of basis in partnership; Nontaxable to extent of basis in ; Ability to make special tax allocations among owners? Yes, but must have substantial economic effect. Yes, but must have substantial economic effect. Ability to shift entity income among family member owners? To a degree, by manipulating wages of employeeowners. Yes, within limits of family partnership rules. Yes, within limits of family partnership rules. Yes, by employing family members. Possibility of corporate-level built-in gains tax, excess net passive income tax, and LIFO recapture tax if former C corporation? Potential loss of favorable passthrough tax rules if and capital structure rules violated? Treatment of gain on sale of Capital. Gain may be excludable if qualified small business stock. Capital. Capital, unless partnership holds. Capital, unless holds Section 751 assets. Depends on nature of assets. Treatment of loss on sale of Capital unless stock is Section 1244 stock. Capital unless stock is Section 1244 stock. Capital. Capital. Depends on nature of assets. At-risk rules apply? No, unless closely held. Yes, at shareholder Yes, at partner Yes, at member Section 179 dollar limitation applied at single level? The dollar limitation applies at the S corporation level and again at The dollar limitation applies at the partnership level and again at the partner The dollar limitation applies at the level and again at the member

6 the shareholder Ownership interest available to creditors? Limited. Creditor can obtain charging order to receive Limited. Creditor can obtain charging order to receive Valuation discounts available for estate tax valuation? May be limited. IRS may argue for liquidation value. Probably, yes. However may be limited if terminates on death of member. Ability to use tax credits? Offsets corporate tax. Passed through to shareholders to be applied against their taxes. Passed through to partners to be applied against their taxes. Passed through to members to be applied against their taxes. Offsets tax of the individual. Qualified retirement plans for employee/owner? Payments are Payments are Payments to a Keogh, SEP, or SIMPLE are deductible. Payments to employee qualified plans are Payments to a Keogh, SEP, or SIMPLE are deductible. Payments to employee qualified plans are Payments to a Keogh, SEP, or SIMPLE are deductible. Payments to employee qualified plans are Life insurance premiums for employee-owner deductible? Premiums for first $50,000 group-term life are deductible and not taxable to employee. Deductible by corporation as compensation. Health insurance premiums for employee-owner deductible? Deductible by corporation as compensation; 100% more-than-2% shareholder. Typically partnership as guaranteed payment; reported as income by partners; 100% partners. Typically as guaranteed payment; reported as income by members; 100% members. Income taxed to owners? Tax paid by Maximum rate is 35%. 3% increase for taxable income between $15 million and $18.33 million. Maximum rate Maximum rate Maximum rate Maximum rate Deductibility of losses subject to basis limitation? Losses May create NOL. Losses generally shareholder; Losses generally partner to extent of Losses generally member to extent Losses proprietor.

7 liabilities do not increase basis for deducting losses except for direct loans from shareholder. basis; liabilities may increase basis for deducting losses. of basis; liabilities may increase basis for deducting losses.