Types of Business Part II S Corporations and LLCs
Student Learning Objectives Describe features of the alternative forms of ownership such as S corporations and limited liability company.
Alternative Forms of Ownership In addition to the sole proprietorship, the partnership, and the corporation, entrepreneurs can choose other forms of ownership, including the S corporation, the limited liability Corporation (LLC), and joint venture. We will discuss S corporation and LLC in these notes.
The S Corporation The Internal Revenue Service Code created the Subchapter S corporation in 1954. An S corporation is a distinction that is made only for federal income tax purposes and is in terms of its legal characteristics, no different from any other corporation.
S Corporation Criteria It must be a domestic (U.S.) corporation. It cannot have a nonresident alien as a shareholder. It can issue only one class of common stock. It cannot have more than 100 shareholders. No more than 25% of the corporation s gross revenues during three successive tax years can be from passive investment income.
New S Corporation Laws By increasing the number of shareholders to 100, founders can now more easily pass their stock onto their children and grandchildren more easily. This also gives S corporations greater ability to raise capital by attracting more investors.
New S Corporation Laws This law also allows for S corporations to own subsidiary companies. Entrepreneurs can establish an S corporation as the parent company and then set up multiple subsidiaries as either S or C corporations as offspring under it. Can be used to divide different sectors of the corporation.
S Corporation Advantages S corporations retain all of the advantages of a regular corporation. Most notable provision of the S corporation is that it passes all of its profits or losses through to the individual shareholders and its income is only taxed once at the individuals tax rate. This avoids the double-taxation disadvantage of a corporation. S corporations owners also enjoy the ability to make year-end payouts to themselves when net income is high.
S Corporation Disadvantages Congress s constant tinkering with the tax code means that the tax advantages that the S corporation offers may not be permanent. One should consider these factors to make decision to move towards S corporation The size of the company s net profits The tax rates of its shareholders Strategic plans and their timing to sell the company or transition ownership
The Limited Liability Company The limited liability company (LLC) is a hybrid structure that features elements of a partnership and a corporation. Because of the advantages it offers and its flexibility, the LLC is the fastest growing form of business ownership. Although a LLC can have just one owner, most have multiple owners referred to as members.
Advantages of LLC LLC s provide owners with many of the benefits of S corporations but are not subject to the restrictions imposed. Members can still have limited liability risk and avoid the double taxation imposed on C corporations. Income flows through its members who are responsible for paying their own taxes.
Advantages of LLC LLC s permit its members to divide income, as well as, liability as they fit just like in a partnership. These advantages make the LLC an ideal form of ownership for companies in many diverse industries.
Creating a LLC Creating a limited liability company is much like creating a corporation. You must file the articles of organization with the secretary of state including: company s name, method of management, duration and names of members. Also, just like corporations, the company s name must include the wording of Limited Liability Company or LLC.
Operating Agreement The LLC operating agreement is similar to ta corporation s bylaws. The operating agreement must create an LLC that has more characteristics of a partnership than of a corporation to maintain its favorable tax treatment. It cannot have any more than 2 of the following corporate characteristics: Limited Liability Continuity of life Free transferability of interest Centralized management
LLC Disadvantages Despite their universal appeal to entrepreneurs LLC s do have some disadvantages Expensive to create Suited for launching a new company but costly to convert existing. Switching from general partnership or sole proprietorship to bring in new owners is usually not a problem, but S & C corporations can incur large tax obligations if they switch.
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