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Thursday, June 25, 2015

Comparison of Subchapter K v. Subchapter S

Comparison of Subchapter K v. Subchapter S



Balancing stonesBoth Subchapter K and S of the Internal Revenue Code (IRC) are pass-through tax structures in which the members of the entity are taxed for the entity's income, gains, losses, and expenses on their individual tax returns.  That is where the similarities end.  There are several differences discussed below that make Subchapter K seem more taxpayer friendly than Subchapter S.  Much of the popularity of the LLC is attributable to the fact that LLCs offer limited liability to all investors combined with the more flexible partnership tax regime.  In some situations, however, the goals of the business owners may be better achieved with an S corporation.

Subchapter S places very strict restrictions on the ownership and capital structure for S corporations.  S corporations are limited to 100 shareholders (although members of a "family," broadly defined, are counted as one shareholder), and they may not have more than one class of stock.  Additionally, all shareholders much be individual U.S. citizens or residents and other corporations or partnerships cannot be shareholders of the company.  Anyone can be a member or partner of an entity taxed under Subchapter K.

Partnerships and LLCs taxed under Subchapter K may make special allocations of income and deduction items, while shareholders of an S corporation must include corporate income and loss on a pro rata share basis.  Thus, partners/members may agree to share certain income or deductions disproportionately, and the agreement will be respected for tax purposes if it reflects their economic business deal.  Additionally, in most cases, partnerships and LLCs taxed under Subchapter K, can distribute appreciated property in kind without immediate recognition of taxable gain.

In a business with only a few owners, an S corporation may be the entity of choice because the flexibility of Subchapter K is not needed.  S corporations are often used by owners that prefer to conduct their business as a state law corporation instead of a partnership or limited liability company because they are more comfortable with the corporate governance structure.  S corporations are also often used by service providers to minimize their exposure to employment taxes.  S corporations are not viable options in many situations - a business with foreign investors would not be able to make the S corporation election because foreign investors are not permissible S corporation shareholders.  Additionally, many institutional investors (e.g., tax-exempt pension funds and charitable organizations) are discouraged by the tax system from investing in any type of active business that is operated as a pass-through entity.  Venture capital funds, which provide a large source of capital for start-up companies, appear to be more comfortable using the familiar C corporation capitalized with several classes of stock, a structure not available in an S corporation.

For a complete analysis of the tax implications of C Corporations, Partnerships, and S Corporations click here for the Joint Committee on Taxation's publication entitled "Choice of Business Entity: Present Law and Data Relating to C Corporations, Partnerships, and S Corporations."

Attorney Angel Oliver / McGrath and Spielberger, PLLC assists clients with all sorts of tax matters, both federal and state (including but not limited to North Carolina and South Carolina). Click here to contact Ms. Oliver about your tax matter.

Ownership Restrictions Relating to Tax on a Businesses

Ownership Restrictions Relating to Tax on a Business



When you decide to start a business venture, there are a myriad of things to consider.  We regularly assist small business owners, especially start-up businesses, walking them through the steps that need to be taken in order to make the business official and legal.  There are many ways a business can be organized and there are both non-tax and tax factors as well as state and local statutory requirements that need to be taken into consideration when embarking on this exciting journey of starting a business.

I previously wrote an article regarding the non-tax factors that should be considered when starting a business.  This article is one of a series of articles that focuses on the tax implications of certain business activities and things you should consider when choosing your business entity.  The most prominent federal tax considerations in choosing a business entity include:



This article will address the ownership restrictions relating to corporate tax.



An entity (including a limited liability company) may be treated as a partnership for tax purposes regardless of the nature of the business or the number of members or partners.  Thus, the partners or members of the entity may consist of any number of domestic or foreign individuals, corporations, trusts, estates, tax-exempt organizations, or other partnerships.  An unincorporated business entity with more than one owner is taxed as a partnership under Subchapter K of the Internal Revenue Code (IRC) unless it elects to be treated as a corporation.   Partnerships are not treated as taxable entities but the income, gains, losses, and expenses are pass-through to the partners or members who report those items on their individual tax returns.



Certain joint ventures involving passive property or natural resource extraction may elect to be excluded from Subchapter K rules and be treated as co-ownerships.



There are no restrictions on the nature and number of shareholders of a C corporation.  Corporations may engage in any kind of activity permitted by their charters.  Taxation under Subchapter C is not elective for any entity that is incorporated under local law.  Certain unincorporated entities may elect to be treated as a corporation (i.e., an LLC) by electing to be taxed under Subchapter S of the Internal Revenue Code.  The Subchapter S election requires the unanimous consent of all of the corporation's shareholders.



Subchapter S corporations are subject to important limitations on the number and the kind of shareholders they may have.  In order to be able to elect to be taxed under Subchapter S there can be no more than 100 shareholders and all shareholders must be individuals who are US citizens or residents, estates, or certain kinds of trusts.  Corporations, associations, partnerships, LLCs, or foreign nationals cannot be shareholders of an S corporation.



Although a C corporation cannot own stock in an S corporation, an S corporation is permitted to have wholly-owned subsidiaries that are C corporations.



For a detailed comparison of the differences between the tax consequences of Subchapter K and Subchapter S click here.  For a complete analysis of the tax implications of C Corporations, Partnerships, and S Corporations click here for the Joint Committee on Taxation's publication entitled "Choice of Business Entity: Present Law and Data Relating to C Corporations, Partnerships, and S Corporations."



Attorney Angel Oliver / McGrath and Spielberger, PLLC assists clients with all sorts of tax matters, both federal and state (including but not limited to North Carolina and South Carolina). Click here to contact Ms. Oliver about your tax matter.

Monday, June 22, 2015

The Tax Consequences of Capital Contributions in a Business

The Tax Consequences of Capital Contributions in a Business



When you decide to start a business venture, there are a myriad of things to consider.  We regularly assist small business owners, especially start-up businesses, walking them through the steps that need to be taken in order to make the business official and legal.  There are many ways a business can be organized and there are both non-tax and tax factors as well as state and local statutory requirements that need to be taken into consideration when embarking on this exciting journey of starting a business.

I previously wrote an article regarding the non-tax factors that should be considered when starting a business.  This article is one of a series of articles that focuses on the tax implications of certain business activities and things you should consider when choosing your business entity.  The most prominent federal tax considerations in choosing a business entity include:



The first tax consideration I will address is the tax consequence of a capital contribution.

cashCASH CONTRIBUTIONS

When cash is contributed, no gain or loss is recognized, and the contributor's basis for the stock or interest received in the business equals the the amount of cash contributed.

PROPERTY CONTRIBUTIONS

Partnership or LLC

If property is contributed to the business, any gain or loss inherent in the contributed property is deferred until the partnership or LLC sells the asset or the contributing partner/member sells his interest.  The contributing partner/member does not recognize gain or loss at the time of contribution, regardless of his percentage of ownership.  The contributor's basis in the property carries over to the partnership/LLC and it also becomes the basis for the membership/partnership interest the contributor receives for the contribution.  When the contributed property is sold, the gain or loss that was not recognized at the time of the contribution is recognized and allocated to the contributing partner/member.  If the contributed property is distributed to another partner/member within five years of the contribution date, the contributing partner/member recognizes gain or loss on the property.

Corporations

The transfer of appreciated property to a regular or S corporation in exchange for stock is a taxable transaction unless the transferor, together with other parties making contributions at the same time, control the corporation through ownership of at least 80% of its stock.  No gain or loss is recognized if this control requirement is met.  The contributing shareholder's basis for the property carries over to the corporation and also becomes the basis for the stock the shareholder receives in return.

In an S corporation, gain or loss the corporation recognizes when it disposes of the property passes through to the shareholders in proportion to their stock ownership.  Unlike a partnership, the gain or loss is not allocated to the contributing shareholder.

In a C corporation, the corporation is taxable on any gain or loss when the contributed property is disposed of.  There are no current tax consequences to the shareholders.

For a complete analysis of the tax implications of C Corporations, Partnerships, and S Corporations click here for the Joint Committee on Taxation's publication entitled "Choice of Business Entity: Present Law and Data Relating to C Corporations, Partnerships, and S Corporations."

Attorney Angel Oliver / McGrath and Spielberger, PLLC assists clients with all sorts of tax matters, both federal and state (including but not limited to North Carolina and South Carolina). Click here to contact Ms. Oliver about your tax matter.

Tuesday, June 16, 2015

What Factors Should You Consider When Starting a Business?

What Factors Should You Consider When Starting a Business?



When you decide to start a business venture, there are a myriad of things to consider.  You have possibly already chosen the purpose of your venture and what it is you are going to make, do, or sell.  You have probably also played around with what to name your business.  Now what?  Where do you go from here?



We regularly assist small business owners, especially start-up businesses, walking them through the steps that need to be taken in order to make the business official and legal.  There are many ways a business can be organized and there are non-tax factors, tax factors, and state statutory requirements that need to be taken into consideration when embarking on this exciting journey of starting a business.



This article focuses on a few of the non-tax factors that need to be considered.  A follow-up article will discuss the tax factors of organizing your business.  Much of the information in this article relates to the laws in a majority of jurisdictions along with examples of specific instances where North Carolina law is different from the majority of jurisdictions.  The statutory requirements of starting a business are state specific, therefore it is important to seek the assistance of a professional who knows the law in your jurisdiction.  There are also state and local licensing as well as registration requirements that will need to be met depending on the jurisdiction your business will be located in.



In the tables below the entities are listed from the broadest/most flexible to the most restrictive.



limited liability

Limited liability is probably the most sought after attribute of business owners forming a new business venture.  New business owners wish to protect their personal assets from the claims of business creditors.  This can usually be achieved by organizing the venture under a state law that limits the owners' liability to the amount of capital the owner has invested in the entity.  Be very careful when capitalizing the business and applying for loans.  Some lenders may require that the owner(s) of the business provide a personal guarantee for the business obligations, thereby making the owner liable to those creditors of the business and defeating the purpose of the limitation of liability.



management and control

capital structure

transferability of interests

duration of entity

Attorney Angel Oliver/McGrath & Spielberger, PLLC assists clients with all sorts of tax, business, and estate planning matters in North Carolina.  Click here to contact Ms. Oliver about your tax, business, or estate planning matter today.