Choice of Business Entity

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Choice of Business Entity
NSU LAW CENTER
Professor Marilyn Cane
2006
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Choice of Entity
The Form Of Entity

• What Are the EIGHT Basic Choices?
• When Is It Time To Decide?
• What Matters in Deciding Which Form?

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• What Are the Eight Basic Choices?
• Sole Proprietorships -- A Fancy Name for One
  Owner
• Corporations -- C Type
• Corporations--S Type (Federal Tax Election)
• Partnerships -- General
• Partnerships-- Limited
• Limited Liability Companies (LLCs)
• Limited Liability Partnerships (LLPs)
• Limited Liability Limited Partnership (LLLPs)

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• When Is It Time to Decide?
• The "Follow the Money" Rule
• When There Are Multiple Owners/Investors
• When The Business Generates Revenues or Assets

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• What Matters in Deciding Which Form?
• Who Owns (Or Will Own) the Business?
• What is the Nature of Each Owner's Interest?
• Who Manages (or Will Manage) the Business?
• How (and When) Will the Money Flow?
• "Personal Recourse" (Are You Putting Up The
  House)?
• What Happens on April 15?

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• What Matters in Deciding Which Form?
• Who Owns (Or Will Own) the Business?
• One Individual
• A Few Individuals
• Lots of Owners
• Any Corporate Owners (Venture Funding)?
• The Same Group Over Time, Or Will Owners Vary
  (Transfers Among Owners)?

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• What Matters in Deciding Which Form?
• How (and When) Will the Money Flow?
• Investment Self, Venture, Private, Public
• Revenues When in Your Business Plan?
• Expenses How Fast and How Deep?

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• What Matters in Deciding Which Form?
• "Personal Recourse
• Are You Putting Up The House?
• Limited Liability is Commonly a Misnomer

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• What happens on April 15?

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• Tax Treatment of Entities
• Corporations The following are taxed as
  corporations under the Federal Income Tax Code
• State-law Corporations (other than S
  Corporations---S Corporation status is a FEDERAL
  TAX ELECTION having nothing to do with State law)
• Foreign entities on "Corporation List"
• Entities that "elect" corporate tax status
  (including partnerships and LLC's) (This is
  uncommon)

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Tax Treatment of Entities
Effective January 1. 1997, the IRS issued its
final CHECK-THE-BOX regulations
These regulations allow taxpayers to treat most
domestic and foreign unincorporated business
organizations, including LLCs, as partnerships or
corporations on an elective basis.
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• Tax Treatment of Entities
• S Corporations
• Corporations That Are Eligible For, and Elect,
  "Subchapter S" Status with the IRS
• Eligibility requirements include
• 100 or fewer shareholders
• Family members are treated as one shareholder
• Shareholders must be individuals (other than
  non-resident aliens), estates or certain trusts
  or tax exempt organizations
• Only one class of stock (except voting)

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• Tax Treatment of Entities
• Partnerships
• Domestic partnerships and LLCs (with at least 2
  members)
• Other non-corporate entities (LPs, LLPs and
  LLLPs) with at least 2 members that "elect"
  partnership tax status

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• Tax Treatment of Entities
• Layers of Tax
• S Corporations Single layer of Federal and State
  income tax (except for certain States)
• Net income taxed pro rata to shareholders
  (whether or not distributed)
• S Corporation not itself subject to tax
• This is known as pass through taxation. The
  entity is passed through and taxed directly to
  the shareholders of an S corp.

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• Tax Treatment of Entities
• Layers of Tax
• Partnerships Single layer of Federal and State
  income tax
• Partnership itself not subject to tax
• Net income taxed to partners (whether or not
  distributed)
• This is pass through taxation, the partnership
  isnt taxed, the partners are. ( although there
  is a federal tax informational filing by the
  partnership)
• Partners can choose any sharing ratio for tax
  purposes that has substantial economic effect

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• Tax Treatment of Entities
• Layers Of Tax
• C Corporations Double layer of Federal and
  State income tax
• Net income generally taxed to corporation at
  corporate rates (currently up to 35 ) AND
• Distributions, e.g., dividends, generally taxable
  to shareholders
• All Corporations are deemed C corporations
  unless a federal tax election is made to tax as
  an S Corporation (and it qualifies as a S
  corporation)

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Taxation of Dividends in C

• Beginning in 2003 the maximum tax rate on
  qualifying dividends has been dropped to 15 for
  most people. For those in the 15 or 10 bracket,
  qualifying dividends will be subject to a maximum
  tax of only 5. 

In order to qualify for the new lower taxes on
dividends, you're required to hold the stock on
which the dividends are paid for more than 60
days during the 120-day period that begins 60
days before the ex-dividend date. The ex-dividend
date is the last date on which a shareholder of
record is entitled to receive the upcoming
dividend. 
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• Selection of Entities
• Complexity
• Corporations Least complicated, easiest to take
  "public"
• S Corporations Ownership restrictions and only
  a single class of stock allowed
• Partnerships Most complex, substantial tax
  "boilerplate, difficult to take public
• LLCs Like partnerships

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• Selection of Entities
• Flexibility
• Corporations Flexible employee incentives.
  Flexibility on classes of shares, reorganization,
  etc.
• S Corporations All distributions and tax items
  must be shared pro-rata. Limited flexibility on
  employee incentives and reorganizations
• Partnerships LLCs Greatest flexibility making
  distributions and allocating tax items. Limited
  flexibility on employee incentives

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Selection of Entities

• Summary of Corporations
• Double layer of federal and state income tax in C
  Corporation
• Cash distributions taxable as dividends to the
  extent of earnings and profits, then as
  nontaxable return of capital to the extent of
  basis in stock, and then as capital gain
• Least complicated, easiest to take "public"
• Flexible employee incentives
• Flexibility on classes of shares, reorganization,
  etc.

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Selection of Entities

• Summary of Corporations
• Other Issues
• Losses can only be used at the corporate level (
  compare with Partnership taxation where
  partnership losses may be used by the partners to
  offset other income, subject to limitations)
• Dividends are NOT deductible when paid to to
  individuals

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Selection of Entities

• Summary of S Corporations
• Single level of federal income tax
• States differ on whether subject to single, or
  double layer of tax
• Cash distributions taxable only if exceed basis
  in stock
• Eligibility rules include ownership restrictions
  and only a single class of stock allowed

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• Selection of Entities
• Summary of S Corporations cont
• All distributions and tax items must be shared
  pro-rata
• Limited flexibility on employee incentives and
  reorganizations

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• Selection of Entities
• Summary of Partnerships
• Single layer of federal and state income tax
• Cash distributions taxable only if exceed basis
  in partnership interest
• Most complex -- substantial tax "boilerplate"
• Greatest flexibility making distributions and
  allocating tax items

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Selection of Entity
Limited Liability Company The limited liability
company (LLC) is a statutory form of business
entity which operates as a hybrid between a
partnership and a corporation. All states and
the District of Columbia have currently enacted
LLC legislation. .
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The most significant characteristics of an LLC
are that it commonly allows for the pass-through
advantages of a partnership (that is, favorable
tax treatment) and the limited liability of a
corporation, generally limiting an owner's
personal liability to his or her investment.
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• Formation of LLC
• A limited liability company may have one or more
  members.
• i. Members may be individuals, general
  partnerships, limited partnerships, other limited
  liability companies , corporations, trusts,
  business trusts, estates or any other type of
  association. There is no numerical or other
  limit as to membership in an LLC

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ii. This flexibility in membership of an LLC is
unlike an S corporation, which has an upward
limit of 100 stockholders and is limited as to
the type of entity which can own stock and
having only one class of ownership. b. An LLC
is formed by filing with the secretary of the
appropriate state the articles of organization,
which is a document very similar to a
certificate of incorporation
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c. The articles of organization are superior to
the operating agreement, which is a document
setting forth the arrangements among the LLC
members relating to transfers of interest,
management, ownership, voting and other rights,
much in the same way that bylaws and stockholders
agreements of a corporation or the operating
agreement of a partnership. d. There must be
incorporated into the name of the organization
some form of the phrase "limited liability
company or LLC.
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Selection of Entities
LLCs - PROS
TAXED LIKE PARTNERSHIPS
Limited Liability for ALL Members
LLCs-Cons
Very little precedent
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LLC Liability in Florida

• FL ST 608.701 provides
• In any case in which a party seeks to hold the
  members of a limited liability company personally
  responsible for the liabilities or alleged
  improper actions of the limited liability
  company, the court shall apply the case law which
  interprets the conditions and circumstances under
  which the corporate veil of a corporation may be
  pierced under the law of this state.See Dania
  Jai-Alai Palace, Inc. v. Sykes, 450 So.2d 1114
  (Fla. 1984)
• NOTE Only LLCs ( not LPs or LLPs or LLLPs) have
  this protection directing the courts to corporate
  case law

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Selection of Entities
Registered Limited Liability Partnership LLP A
registered limited liability partnership is a
general partnership, which, by satisfying certain
statutory requirements, has insulated its
partners from personal liability arising from the
negligence, malpractice or improper conduct of
other partners or employees of the partnership.
i. This protection is currently available in 35
states and the District of Columbia.
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LLPs in Florida

• Limited Liability Partnerships (LLPs) are
  essentially registered general partnerships that
  choose to file a statement of qualification
  (Fla.Stat. Sec 620.9001)
• Fla. Stat. Sec 620.8306(3) provides that the
  obligation of a P/S incurred while the P/S is an
  LLP whether arising in contract, tort or
  otherwise is solely the obligation of the LLP,
  rather than the partners.

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LPs in Florida

• LP (Limited Partnership) is a P/S formed by two
  or more persons having as members one or more
  general partners and one or more limited
  partners. Fla. Stat. Sec 620.102(7)
• Unlike GPs, LPs are creatures of statute and
  one must file documents with the Secretary of
  State. Fla. Stat. Sec 620.108

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LLLPs in Florida

• LPs may register as a limited liability limited
  partnership (LLLP) Fla. Stat. Sec. 620.187
• By so registering the concept of unlimited
  liability for the general partners is not
  applicable, except if the general partner
  expressly assumes liability or is the actual
  tortfeasor.

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How money goes to shareholders
C CORPORATION
Double Tax Taxed at Corporation Level
Shareholder level
Dividends NON deductible
Salary Deductible
Repurchase of stock-depends
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Partnership Taxation ONE level only
PROFITS pass through to Partners Caveat Even
if the profits are not actually distributed
LOSSES Pass through to Partners