Today, businesses have more legal and financial options than ever before. Choice of business entity is one of the most critical. The choice of entity affects many things — tax treatment, liability, organizational requirements — that will affect a business throughout its lifetime.
At Einbinder & Dunn, LLP, headquartered in New York, we help businesses in the New York metropolitan area and nationwide select the right entity. When we work with you, we take time to learn the nature of your business and then tailor our counsel to your goals and business needs.
Depending on your business objectives, we may suggest utilizing a corporation, partnership or limited liability company:
- Corporations: The corporation, including a professional corporation (P.C.), is a long-used business entity intended to shield its owners from liability.
- Partnerships: Partnership is a flexible business form that has preferential tax treatment but leaves its owners open to liability, which makes it less favored. Limited partnerships offer a variation on this concept.
- Limited liability companies (LLC): LLCs are hybrid entities possessing features commonly associated with corporations and with partnerships. Because of their hybrid nature, LLCs have proven to be a preferred entity form for start-up small businesses because of their limited liability protection, preferable tax treatment and less stringent organizational requirements.
Limited Liability
Like both C Corporations and S Corporations, LLCs afford their owners (referred to as "Members") limited liability in connection with the obligations of the LLC. Partners of a general partnership are not afforded limited liability protection. In some instances, partners of a limited partnership may also be entitled to limited liability protection while the general partner remains liable for the partnership's obligations.
Tax Treatment
LLCs, like a partnership, are pass-through entities, meaning that the LLC is not taxed on its profits and losses, but rather, the profits and losses are passed directly to the LLC's Members. The profits and losses of the LLC are then reported as part of each Member's personal income tax returns and are taxed at the applicable personal income tax rate.
C Corporations are taxed at the applicable corporate income tax rate, and, in the event that the C Corporation distributes monies to its shareholders, the distributions will be taxed at the applicable personal income rate as part of each shareholder's personal income tax returns. This double taxation is a major drawback of C Corporations. However, in certain instances, the double taxation of C Corporations may prove beneficial.
For example, because corporate income tax rates are lower than personal income tax rates, C Corporations may wish to retain income rather than distributing monies to shareholders, thus paying less taxes overall than an LLC generating the same profit level. In this scenario, more money would be available to the C Corporation for financing growth, repaying debt and making capital expenditures than would otherwise be available to the LLC.
Shareholders of a C Corporation can escape double taxation, if they so choose, by electing to have the C Corporation treated as an S Corporation. S Corporations are taxed like LLCs with the profits and losses of the corporation passed through directly to the shareholders.
Organizational Requirements
An LLC is dissimilar to an S Corporation to the extent that certain restrictive organizational requirements are imposed on S Corporations. To qualify as an S Corporation, several requirements must be met, including:
- Ownership of shares in an S Corporation is limited to U.S. citizens and certain trusts and estates (partnerships, corporations and nonresident aliens may not own shares in an S Corporation).
- An S Corporation may not consist of more than 100 shareholders.
- An S Corporation may only offer one class of stock conferring to its shareholders identical rights to distributions.
LLCs are not subjected to similar restrictions. In fact, unlike the S Corporation, both LLCs and C Corporations may have various classes of owners, each class with a different profit allocation method, thus providing for greater investor flexibility. LLCs have even greater flexibility than C Corporations in that the members of a class of an LLC may agree on different distribution rights for each member rather than splitting distributions according to stock ownership, as required in C Corporations.
It should be noted that, because a C Corporation must qualify to be treated as an S Corporation, it is possible that a subsequent event may result in the termination of the S Corporation status thereby subjecting the entity to C Corporation treatment.
Both C Corporations and S Corporations are required by statute to hold an annual meeting of their respective shareholders, a time-consuming and possibly expensive requirement that is not imposed upon LLCs. However, LLCs are required to incur costs not imposed on corporations. All LLCs doing business in New York are required to publish an initial announcement in print for six consecutive weeks in certain types of periodicals, the cost of which can range between $1,000 and $1,500 depending on the county in which the LLC is located. Failure to comply with the publication requirement will result in a suspension of the LLC, as per the 2006 Amendment to the Limited Liability Company Law. It is not clear at the moment what the consequences are of suspension, but it is possible that the LLC will not have access to New York courts, which had been the previous sanction imposed on LLCs for a failure to publish.
Our Recommendation
At Einbinder & Dunn, LLP, we generally recommend to our clients that they choose the LLC form to operate their start-up businesses despite the fact that LLCs are more expensive to form than corporations. It is our opinion that the benefits of an LLC, including the limited liability protection, pass-through taxation and less restrictive organizational requirements, make the LLC form preferable to both C Corporations and S Corporations as the entity choice for the operation of a small business.
For questions or additional information about Einbinder & Dunn's business law services, please contact Einbinder & Dunn by clicking here to fill out a contact form or by calling 866-490-4909 or 212-391-9500 to speak with one of the firm's partners.
On Monday, April 16th, 2012, Julie Lusthaus was interviewed in a 30 minute segment about Franchising on WVOX 1460 AM radio by Marsha Gordon, President & CEO of The Business Council of Westchester.
