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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
LLC
(Single-Member or Multi-Member)
Partnership
(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,
pension plans,
C corps, partnerships, LLCs, certain trusts
None
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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DAVID STIEFEL
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SCOTT USHER
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