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Considerations in Making the Choice of Business Entity

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Presentation on theme: "Considerations in Making the Choice of Business Entity"— Presentation transcript:

1 Considerations in Making the Choice of Business Entity
Sole Proprietorship LLP LLC Partnership S Corporation C Corporation Considerations in Making the Choice of Business Entity

2 1. Sole Proprietorship

3 General Partnership - Registered Limited Liability Partnership

4 3. Limited Partnership

5 4. Limited Liability Company (LLC)

6 5. S Corporation

7 6. C Corporation

8 7. Disregarded Entity

9 Sole Proprietorship Partnership LLC S Corporation C 1. Limited Liability No General Partner has no liability protection, except liability shield provided by election to be a Registered Limited Liability Partnership. Limited partners have limited liability protection unless provided otherwise. All members have limited liability protection from the LLC’s debts, unless provided otherwise All shareholders have limited liability protection unless otherwise Provided Shareholders have limited liability protection unless otherwise provided 2. Levels of Federal Income Tax One Generally, one. Two, if a former C corporation and too much passive income or built-in gains under Sec and 1375 Two 3. Texas Franchise Tax Yes

10 No restrictions, but at least two to be onsidered a partnership
Sole Proprietorship Partnership LLC S Corporation C 4. Number Of Owners One At Least two No restrictions, but at least two to be onsidered a partnership One to 75 No Restric-tions 5. Types Of Owners N/A Any Ownership is limited to U.S. Citizens and residents and to certain U.S. trusts. No corporate (except S corporation which is 100% owner) or partnership shareholders 6. Classes of Ownership Interests Multiple classes are permitted Only one class of stock is permitted. However, there can be differences in voting rights, and debt may be used. Multiple Classes are Permitted

11 Sole Proprietorship Partnership LLC S Corporation C 7. Voting Rights of Equity Holders N/A Voting rights of equity holders are usually specifically set forth in the Partnership Agreement. To the extent the Partnership Agreement does not address voting rights of equity holders, Texas statutory law controls Voting rights of equity holders are usually specifically set forth in the Regulations (an agreement among all of the equity holders). To the extent the Regulations do not address voting rights of equity holders, Texas statutory laws control A. Board of Directors B. Mergers, conversion, sale of substantially all assets, dissolution -Shareholders C. Amendments of Articles of Incorporation and maybe Bylaws -Shareholders (voting rights may be modified by Share-holders’ Agreement or Voting Agreement) Same as S Corp-oration

12 The filing fee in Texas for a Texas Limited Partnership is $750.
Sole Proprietorship Partnership LLC S Corporation C 8. Restriction on Ownership of Subsidiaries No restrict-ions No restrictions Can own 100% of the Stock of another S Corporation. 9. Tax Year Calen-dar Generally calendar 10. Organiza- tional Costs N/A The filing fee in Texas for a Texas Limited Partnership is $750. The filing fee in Texas for a Texas LLC is $200 The filing fee in Texas for a Texas corporation is $300

13 Sole Proprietorship Partnership LLC S Corporation C 11. Day to day Manage- ment Structure N/A General Partner Members or Managers Board of Directors/ officers (unless otherwise provided in Shareholders’ Agreement) Same as S Corporation 12. Taxation of Contributions of Property to Entity Non-Taxable Nontaxable unless disguised sale, violate investment partnership rules or the partner is relieved from debt in excess of basis. Nontaxable unless disguised sale, violate investment partnership rules or the member is relieved from debt in excess of basis. Taxable, unless the transferors meet the 80% control test of IRC §351, in which case the transfer is nontaxable except to the extent of debt relief in excess of basis.

14 38.6 % 35 % N/A Yes No Sole Proprietorship Partnership LLC S
Corporation C 13. Maximum Marginal Federal Tax Rate on Income from Business 38.6 % 35 % 14.Special Tax Allocations of Income and Loss N/A Yes No 15. Deductibility of Losses (and basis for entity-level debt) Generally no restrict-ions A partner may deduct his allocable share of partnership’s losses only to the extent of his tax basis in his partnership interest which could include his allocable share of partnership debt. A member may deduct his allocable share of LLC’s losses only to the extent of his tax basis in his LLC interest which includes his allocable share of LLC debt. A shareholder may deduct his allocable share of corporation’s losses only to the extent of his tax basis in his stock which does not include any portion of the corporation’s debt but does include shareholder debt to corporation Shareholders may not deduct any of the corporation’s losses.

15 Nontaxable to the extent of a member’s tax basis in his LLC interest
Sole Proprietorship Partnership LLC S Corporation C 16. Taxation of Cash Distri-butions N/A Nontaxable to the extent of a partner’s tax basis in his partnership interest. Nontaxable to the extent of a member’s tax basis in his LLC interest Generally non-taxable to the extent of the shareholder’s tax basis in his stock Taxable as dividends to the extent of the corporation’s earnings and profits and then nontaxable to the extent of the shareholder’s tax basis in his stock.

16 Taxation of Distri-butions of Appre-ciated Property
Sole Proprietorship Partnership LLC S Corporation C 17. Taxation of Distri-butions of Appre-ciated Property N/A Generally Nontaxable; but can be taxable based on unequal distribution of §751 assets (“Hot Assets”) or distributions of property contributed by one partner to another within 7 years of contribution. (“Hot Assets”) or distributions of property contributed by one member to another within 7 years of contribution. Taxable to Both and Share-holders. Same as S Corporation

17 Taxation Upon Liquidation
Sole Proprietorship Partnership LLC S Corporation C 18. Taxation Upon Liquidation N/A Generally Nontaxable; but can be taxable based on unequal distribution of §751 assets (“Hot Assets”) , distributions of property contributed by one partner to another within 7 years of contribution or distributions of cash in excess of partner’s tax basis in his partnership interest. (“Hot Assets”) , distributions of property contributed by one member to another within 7 years of contribution or distributions of cash in excess of members’s tax basis in his partnership interest. Taxable to both and Shareholders Same as S Corporation

18 Transfer Restrictions Imposed by Tax Considerations
Sole Proprietorship Partnership LLC S Corporation C 19. Transfer Restrictions Imposed by Tax Considerations NO Generally, No. Certain transfers of 50% or greater percentage can terminate entity for tax purposes. Assignee Generally Cannot Become Limited partner Without Majority consent Assignee generally cannot become full member without majority consent of LLC or other members. Yes. No transfers to an ineligible share-holder. Cannot exceed 100 share-holders. 20. Section 754 Election to Adjust Inside Basis of Entity Assets Upon Sale of an Owner’s interest or taxable Distribution of Property N/A YES Yes

19 Ability to use written consents
Sole Proprietorship Partnership LLC S Corporation C 21. Ability to use written consents N/A No, unless in Agreement Yes 22. Annual meetings/ resolution, necessary for perpetuation of management NO Yes (unless Share- holders’ Agreement provides for perpetual management) Same as S Corporation 23. Classification for federal income tax purposes Sole Proprietorship or Partnership unless affirmative election is made to be taxed as an Association (i.e. Corporation)

20 DISCUSSION QUESTIONS 1. When might an S corporation be preferable to an LLC or LP? 2. When is a single member LLC not a good idea? 3. When, if ever, is a C corporation appropriate?

21 DISCUSSION QUESTIONS 4. When would an LLC be preferable to an LP? 5. Can you have a 0% General Partner in a Limited Partnership? 6. What is the level of protection a Registered Limited Liability Partnership provides to its partners?

22 REGISTERED LIMITED LIABILITY PARTNERSHIP (“RLLP”)
A. Requirements. 1. Name must include the words “registered limited liability partnership” or “limited liability partnership” or the abbreviation “LLP” or “L.L.P.” 2. Registration with the Secretary of State; $200 per Partner annual filing fee. 3. Liability Insurance of $100,000 or $100,000 of designated segregated funds

23 B. Liability Shield Limitations.
1. Liability Protection Not Available if: a. Partner directly supervised or directed the negligent partner or representative; b. Partner directly involved in specific negligent activity committed by other partner or representative; or c. Partner had notice or knowledge of omissions, errors, or negligence and failed to take reasonable steps to cure or prevent such actions.

24 B. Liability Shield Limitations (cont.)
2. Actions or omissions detailed in 1 above are fact questions. 3. Minimal case law interpreting.

25 Texas Franchise Tax Planning
Conversion of Corporation to Limited Partnership EXISTING PICTURE: Individual Shareholders 100% Corporation (TX) [S Corp]

26 Texas Franchise Tax Planning
Conversion of Corporation to Limited Partnership STEP ONE: Form the Holding Company, a Texas general partnership; make election for the Holding Company to be taxed as a corporation followed by S election (Note: Under IRC Reg. § T(c), an entity that timely files S-election (Form 2553) is deemed have made election to be classified as a corporation (Form 8832)). Individual Shareholders 100% Corporation (TX) [S Corp] Holding Company (TX GP) [taxed as S Corp]

27 Texas Franchise Tax Planning
Conversion of Corporation to Limited Partnership STEP TWO: Transfer 100% of stock ownership in the Corporation to the Holding Company. The Holding Company then makes a Q Sub election for the Corporation. Individual Shareholders Holding Company (TX GP) [taxed as S Corp] Corporation TX [Q Sub]

28 Texas Franchise Tax Planning
Conversion of Corporation to Limited Partnership STEP THREE: The Holding Company forms the General Partner (a corporation or LLC) and transfers a nominal % of the Corporation’s stock to the General Partner as its capital contribution (Consider 0% GP: See Section 4.01 of the TX Limited Partnership Act). Holding Company (TX GP) [taxed as S Corp] 100% General Partner (TX) [Disregarded] 99.75% 0.25% Corporation (TX) [Q Sub]

29 Texas Franchise Tax Planning
Conversion of Corporation to Limited Partnership STEP FOUR: Convert the Corporation into the Partnership (a Texas limited partnership) with General Partner as the sole general partner of the Partnership and the Holding Company as sole limited partner of the Partnership. Holding Company (TX GP) [taxed as S Corp] 100% 99.75% LP General Partner (TX) [Disregarded for FIT] 0.25% GP Partnership (TX) Disregarded for FIT


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