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New business alphabet-soup Featured

9:25am EDT March 28, 2002
Starting a business is an exciting endeavor. You've got great ideas, talent and excitement, all of which are necessary to make the business succeed. What kind of structure will you choose for organizing your business? Do you form a regular (C) corporation? Or a small business (S) corporation? Or maybe a limited liability company (LLC) or limited partnership (LP)? Before you decide, think about flexibility in ownership and operation, tax consequences for the owners and the impact on your ability to unwind or sell the business. Here's how these factors fit into some organizational choices for your new business.* C Corporations. C corporations have many advantages. Your personal assets are protected from corporate liabilities as long as you follow formalities and adequately capitalize and insure the corporation. The corporation may have two or more classes of stock, with different rights to dividends and liquidation proceeds. There are no employment taxes on your share of corporate profits above your salary and other compensation. Unfortunately, you'll be subject to a double-tax burden: the corporation pays tax on its profits, and you pay tax again when you receive cash distributions. In connection with a sale of the corporation's assets for cash, the effective tax rate could be as high as 55 percent, compared to roughly 25 percent for the sale of assets of other entities. * S Corporations. Issues of corporate formalities, limited liability and employment taxes are largely the same as for a C corporation. But on the tax front, an S corporation is a pass-through entity. This generally means S corporations are not subject to corporate-level taxes. Instead, income and loss of the corporation pass through to shareholders' personal tax returns. Shareholders are taxed on corporate income, even if cash is not distributed to them. S corporations are subject to rigid rules. For example, most corporations, partnerships, LLCs and other entities may not own shares in S corporations. Moreover, preferred stock is prohibited, because each share must convey identical economic rights.* LLCs. LLCs have only recently arrived on the financial scene, but are now accepted in all 50 states. Like an S corporation, the LLC provides limited liability protection for its owners and is a pass-through entity. But unlike an S corporation, there are no rigid rules regarding who can be an owner or how profits and losses may be shared. The biggest downside is self-employment taxes. Under current law, each active LLC member may be subject to self-employment tax on 100 percent of his or her share of profits rather than simply on compensation.* Partnerships. Considerations for general and limited partnerships are substantially similar to those for LLCs. But, in most cases, an LLC provides more management flexibility without sacrificing limited liability, making the LLC form the better option.If you're concerned with flexibility, tax savings and limited liability, and self-employment taxes aren't much of a factor (for instance, because you already have exceeded the maximum threshold for the Social Security portion of the employment tax from other sources), the LLC form may be right for you. In any event, consult with your legal and tax advisers for assistance. Dan L. Jaffe and Eliot N. Meyers are attorneys at Vorys, Sater, Seymour and Pease LLP. They can be reached at Vorys, Sater, Seymour and Pease, (614) 464-6400 or www.vssp.com

Vorys, Sater, Seymour and Pease