Updated 3.12.2018 for changes resulting from the Tax Cuts and Jobs Act
Some things you just have to do right the first time, or you risk locking in problems and limiting potential.
The right choice of entity for your new venture — whether LLC, partnership, S corporation or C corporation — is one of those things.
To raise money from venture capitalists or institutional investors, you pretty much need to be a C corporation. If you want limited liability, don’t form a general partnership. And if you want to qualify for preferential tax treatment of Qualified Small Business Stock, form a C corporation.
The choice of entity is a complex one that requires a longer-term vision and thoughtful consideration of a range of matters such as those listed below.
Each choice of entity has nuances that cannot be fully explored here, and there are other considerations that may apply based on your specific circumstances. Consult your tax advisor and/or your attorney to explore the alternatives.
|Choice of Entity Considerations for a New Venture|
(Single-Member or Multi-Member)
(General or Limited)
|S Corp||C Corp|
|Formation and Ownership|
|Maximum number of owners allowed||Not limited||Not limited||100||Not limited|
|Ineligible owners||None||None||Nonresident aliens¹,
C corps, partnerships, LLCs, certain trusts
|Limited personal liability for owners||Yes, even for members who participate in management||No for general partners; Yes for limited partners not participating in management||Yes, even for shareholders who participate in management||Yes, even for shareholders who participate in management|
|Suitable for VC and institutional investors||Unlikely||Unlikely||No||Yes|
|Readily convertible to C corp||No||No||Yes||N/A|
|Multiple classes of owners allowed||Yes||Yes||No, except for different voting rights||Yes|
|Transferability of interest||Yes, unless restricted in LLC agreement||Yes, excluding general partnership interests||Yes, unless restricted in shareholder agreement||Yes, unless restricted in stockholder agreement|
|Owners eligible to be employees||No||No||Yes||Yes|
|Eligible for Qualified Small Business Stock benefits||No||No||No||Yes|
|Contribution of property for equity||Generally no gain or loss||Generally no gain or loss||Generally no gain or loss, assuming transferors control||Generally no gain or loss, assuming transferors control|
|Contribution of services for equity||Generally taxable (multi-member)||Generally taxable||Generally taxable||Generally taxable|
|Perpetual life||Yes, with restrictions||Yes, with restrictions||Yes||Yes|
|Finance and Operations|
|Taxable year||Generally calendar||Generally calendar||Calendar or limited fiscal year||Calendar or fiscal, with limitations on subsequent changes|
|Files separate tax return from owners||Yes, if multi-member||Yes||Yes||Yes|
|Taxation of income||At member level, using their rates||At partner level, using their rates||At shareholder level, using their rates||At corporate level, using corporate rates|
|Limits on loss deductions||Deductible to extent of basis, including debt||Deductible to extent of basis, including debt||Deductible to extent of basis, including direct shareholder loans||N/A|
|Allocation of income and deductions||Limited flexibility||Limited flexibility||Per share||N/A|
|Management||Members — or manager, if appointed||General partner||Board of Directors, which can include shareholders||Board of Directors, which can include shareholders|
|Tax-free fringe benefits||Members not eligible||Partners not eligible||Shareholder employees who own 2% or more are not eligible||Shareholder employees are eligible|
|Maximum tax rate²||Owner’s rate, up to 37%||Owner’s rate, up to 37%||Owner’s rate, up to 37%||21%|
|Eligible for 20% 199A deduction³||Yes||Yes||Yes||No|
|Employment taxes||Self-employment tax on member guaranteed payments and share of business income||Self-employment tax on partner guaranteed payments and share of business income||FICA only on compensation||FICA only on compensation|
|Exits and Transitions|
|Ownership transfers||Per LLC agreement||Limited partnership interest is transferable subject to partnership agreement.
A general partnership interest is not
|Per shareholder agreement, and subject to restrictions on types of owners||Per shareholder agreement|
|Tax consequences of liquidations||No gain or loss recognized, assuming adequate basis||No gain or loss recognized, assuming adequate basis||Gain or loss recognized by corporation and taxable to shareholders||Gain or loss recognized by corporation and shareholders|
¹ A nonresident alien is generally barred from owning stock in an S corporation. To do so would terminate the S corporation election. However, as a result of the Tax Cuts and Jobs Act, a nonresident alien can use an Electing Small Business Trust (ESBT) to buy stock in an S corporation.
² The non-corporate tax brackets and rates return to 2017 amounts after 2025.
³ The 199A deduction is subject to limitations and currently expires after 2025.
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