Business

Choice of Entity
ETR 4070 Enterprise Law
Spring 2015
Prof. John Gustincic

HABIT

***
You are today where your thoughts have brought you;
you will be tomorrow where your thoughts take you.
***
Men are anxious to improve their circumstances, but are
unwilling to improve themselves; the therefore remain
bound.
James Allen

Sole Proprietorship Sole Prop.

The sole proprietor is an unincorporated business with one owner
who pays personal income tax on profits from the business. With
little government regulation, they are the simplest business to set
up or take apart.
Profit/Loss reported on Schedule C of individual tax return
Self-employed individuals are responsible for the entire FICA tax
rate of 15.3 percent (12.4 percent Social Security plus 2.9 percent
Medicare).
Unlimited personal liability.
Good will?

Partnership
Business association of two or more persons to conduct business

Types:
General Partnership unlimited liability
Limited Partnership limited liability (to the extent of investment)

Tax
Partnership tax: IRS Form 1065 http://www.irs.gov/pub/irs-pdf/f1065.pdf

Flow-through entity (partnership does not pay tax, gains and losses flowthrough to individual partners tax returns Schedule C)
http://www.irs.gov/pub/irs-pdf/f1040sc.pdf

Single Member Limited Liability

Company
Owner: Member (not shareholder)

Taxation: Schedule C (not a separate entity for tax purposes)

Multi-Member LLC
Two or more members (in Michigan tenants by the entirety husband
and wife count as one member)
Treated as a partnership for tax purposes and must file IRS Form 1065
Flow-through entity Gains and losses pass to Schedule C of individual
members
Limited Liability
May be closely held (restrictions on transfer of interest)
Gains subject to Self-employment ax 15.3%
12.4% Social Security & 2.9% Medicare

Limited Liability Company

Unincorporated entity organized under State law

Name must contain: LLC, LC, ltd. liability company, limited co., or
ltd. co. (notice of limited liability)
Governing instruments:
Articles of Organization filed with State of Michigan
http://www.dleg.state.mi.us/bcsc/forms/corp/llc/700.pdf
Operating Agreement (not required, but a MUST when you have more
than one member)

Owners: Members

Limited Liability Company

Management: Managers or members

Voting: One member = one vote, operating agreement should

detail
Who can be an owner? No restriction
Number of owners? No restriction
Allocation of distributions? Members can agree on any financial
arrangement (economic reality)

January 29, 2014 - start

Misc.
LLCs do not issue stock
Partnership partner liability
Joint and several liability
May force 1 partner to pay 100% of
claim/debt
Partner paying the 100% owns just 25% of
partnership must then pursue a contribution
action from the other partners

Subchapter S Corporation
A corporation organized under State law. Must elect subchapter
S status by filing election with IRS form 2553 http://www.irs.gov/pub/irspdf/f2553.pdf

All S-Corps start as C (regular) Corporations

Name
Must contain corporation, incorporated, company, limited, corp., co., inc.,
or ltd.

Professional corporation: must state PC or professional corporation

Subchapter S Corporation
Governing Instruments

Owners

Articles of Incorporation
filed with state

Shareholders

Bylaws (see Blackboard)

Various contracts are
allowed among
shareholders such as
stock purchase
agreements and voting
trusts.

Subchapter S Corporation
Management Authority

Directors and officers

Who can participate in

management?

Shareholders elect
directors who make
corporate decisions and
who elect officers to
perform and carry out
directives

Subchapter S Corporation
Voting

Liability for entity obligations?

Shareholders vote based

on number of shares
owned. Majority vote of
shares of those entitled to
vote controls.

Shareholders are not

liable for the obligations
of the corporation,
subject to the few
instances where creditors
have pierced the
corporate veil.

There may be a
nonvoting class of shares,
but otherwise only one
class permitted (no
preferred, common, set
up).

Subchapter S Corporation
Fiduciary duties of
management

Officers and directors have

statutory duties of good
faith to act in the best
interest of the corp. and
not to usurp corp.
opportunities. If minority
shareholders are oppressed
by the majority
shareholders, they majority
shareholders may be liable.

Who can be an owner?

Numerous restrictions,
including disallowing
ownership by nonresident aliens,
partnerships, and
corporations

Feb. 3, 2015

Subchapter S Corporation
Number of owners

Allocation of distributions

At least 1 but no more

than 100 shareholders
(an entire immediate
family would count as just
1 shareholder)

Because only one class

of stock is allowed,
shareholders share of
distributions must be
based on proportionate
stock ownership:
If you own 10% of stock,
you must receive 10% of
the total distribution

Subchapter S Corporation
Transfers of ownership interests

Taxation

Stock is freely
transferable unless
restricted by articles,
bylaws, or a
shareholders agreement
(see Blackboard)

Pass-through taxation to
owners generally not
taxed at corporate level
(no double corporate
taxation like you have
with C corporation)
Tax form 1120 S
IRS form K-1

Subchapter S Corporation
Taxable Year

Owners Deductibility of Losses

Generally, must use

calendar year rare
exceptions!

Can deduct to extent of

stock basis.

Subchapter S Corporation
Cash Distributions to Owners

Limitations on Distributions

Treated as return of basis

and not taxable to
extent of basis. Any
excess will be taxed as
capital gain.

No distribution to owners,
if, after giving effect to it,
the corporation would
not be able to pay its
debts as they become
due or its liabilities would
exceed its assets.

Subchapter S Corporation
Conversions and Combinations

In converting to
partnership or LLC, the
corporation will be
deemed liquidated and
assets contributed to the
new LLC or partnership.

Subchapter S Corporation - stats

According to the IRS, in 2011 there were
4,158,572 S corporations; 99.4% had 10 or fewer
shareholders.

The Census Bureau estimates that in 2012 about

2.9 million S corporations employed more than
29 million people
http://www.pewresearch.org/fact-tank/2014/07/07/what-is-aclosely-held-corporation-anyway-and-how-many-are-there/

C Corporation