Thursday, June 25, 2015

Comparison of Subchapter K v. Subchapter S

business taxes, subchapter K versus subchapter S taxes, IRS
Both 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.

business entities
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."

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 an attorney about your tax matter.

Tuesday, June 16, 2015

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.

Limit Liability for Business Entities

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.

Business Entity Management and Control Comparison Chart
Business Entity Capital Structure
Transferability of Business Interests chart
Duration of the Business Entity chart

The business lawyers McGrath & Spielberger, PLLC assists clients with all sorts of tax, business, and estate planning matters in North Carolina.  Click here to contact us about your tax, business, or estate planning matter today.