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Close Corporation
There are a few minor, but significant, differences between
general corporations and close corporations. In most
states where they are recognized, close corporations
are limited to 30 to 50 stockholders. In addition,
many close corporation statutes require that the
directors of a close corporation must first offer
the shares to existing stockholders before selling
to new shareholders. This type of corporation is
particularly well suited for a group of individuals
who will own the corporation with some members
actively involved in the management and other
members only involved on a limited or indirect
level.
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S Corporation
With the Tax Reform Act of 1986, the S Corporation became a
highly desirable entity for corporate tax purposes.
An S Corporation is not really a different type of
corporation. It is a special tax designation applied
for and granted by the IRS to corporations that have
already been formed. Many entrepreneurs and small
business owners are partial to the S Corporation
because it combines many of the advantages of a sole
proprietorship, partnership and the corporate forms
of business structure.
S Corporations have the same basic advantages and
disadvantages of general or close corporation with
the added benefit of the S Corporation special tax
provisions. When a standard corporation (general,
close or professional) makes a profit, it pays a
federal corporate income tax on the profit. If the
company declares a dividend, the shareholders must
report the dividend as personal income and pay more
taxes.
S Corporations avoid this "double taxation" (once at the
corporate level and again at the personal level)
because all income or loss is reported only once on
the personal tax returns of the shareholders.
However, like standard corporations (and unlike some
partnerships), the S Corporation shareholders are
exempt from personal liability for business debt.
S Corporation Restrictions
To elect S Corporation status, the corporation must meet
specific guidelines. As a result of the 1996 Tax
Law, which became effective January 1, 1997, many of
these qualifying guidelines have been changed. A few
of these changes are noted below:
Prior to the 1996 Tax Law, the maximum number of
shareholders was 35. The maximum number of
shareholders for an S Corporation has been increased
to 75.
Previously, S Corporation ownership was limited to
individuals, estates, and certain trusts. Under the
new law, stock of an S Corporation may be held by a
new "electing small business trust." All
beneficiaries of the trust must be individuals or
estates, except that charitable organizations may
hold limited interests. Interests in the trust must
be acquired by gift or bequest — not by purchase.
Each potential current beneficiary of the trust is
counted towards the 75 shareholder limit on S
Corporation shareholders.
S Corporations are now allowed to own 80 percent or more of
the stock of a regular C corporation, which may
elect to file a consolidated return with other
affiliated regular C corporations. The S Corporation
itself may not join in that election. In addition,
an S Corporation is now allowed to own a "qualified
subchapter S subsidiary." The parent S Corporation
must own 100 percent of the stock of the subsidiary.
Qualified retirement plans or Section 501(c)(3) charitable
organizations may now be shareholders in S
Corporations. All S Corporations must have shareholders who are citizens or
residents of the United States. Non resident aliens
cannot be shareholders.
S Corporations may only issue one class of stock. No more than 25 percent of the gross corporate income may be
derived from passive income.
An S Corporation can generally provide employee benefits and
deferred compensation plans.
S Corporations eliminate the problems faced by standard
corporations whose shareholder-employees might be
subject to IRS claims of excessive compensation.
Not all domestic general business corporations are eligible
for S Corporation status. These exclusions include:
a financial institution that is a bank; an insurance
company taxed under Subchapter L; a Domestic
International Sales Corporation (DISC); or certain
affiliated groups of corporations.
Keep in mind, these lists of qualifying S Corporation aspects
are not all-inclusive. In addition, there are
specific circumstances in which an S Corporation may
owe income tax.
How to File as an S Corporation
To
become an S Corporation, you must know the mechanics
of filing for this special tax status. The first
step is to form a general, close or professional
corporation in the state of your client's choice.
Second, obtain the formal consent of the
corporation's shareholders. This consent should be
noted in the corporation's minutes. Once the filing
is approved, the company must complete Form 2553,
Election by a Small Business Corporation. This form
must be filed with the appropriate IRS office for
your region. Please consult the IRS' instructions
for Form 2553 to determine your proper deadline for
completing and submitting this form.
Limited Liability Company (LLC)
LLCs have long been a traditional form of business structure
in Europe and Latin America. LLCs were first
introduced in the United States by the state of
Wyoming in 1977 and authorized for pass-through
taxation (similar to partnerships and S
Corporations) by the IRS in 1988. With the recent
inclusion of Hawaii, all 50 states and Washington,
D.C. have now adopted some form of LLC legislation
for both domestic and foreign (out of state) limited
liability companies.
Many business professionals believe LLCs present a superior
alternative to corporations and partnerships because
LLCs combine many of the advantages of both. With an
LLC, the owners can have the corporate liability
protection for their personal assets from business
debt as well as the tax advantages of partnerships
or S Corporations. It is similar to an S Corporation
without the IRS' restrictions.
Advantages of an LLC
As with the S Corporation listing, these lists are not
inclusive. For more detailed information, please be
sure to speak with a qualified legal and/or
financial advisor.
Important Note Regarding the Federal Taxation of LLCs:
Before January 1, 1997, the Internal Revenue Service
determined whether a limited liability company would
be taxed "like a partnership" or "like a
corporation" by analyzing its legal structure or by
requiring the members to elect the tax status on a
special form. Effective January 1, 1997, the IRS has
simplified this process.
Pursuant to these new IRS regulations, if a limited liability
company has satisfied IRS requirements, it can be
treated as a partnership for federal tax purposes.
As such, LLCs are required to file the same federal
tax forms as partnerships and take advantage of the
same benefits. However, this is still a highly
technical area, and if you require further
information, it is recommended that you communicate
with the Internal Revenue Service or consult a
competent professional such as a qualified tax
accountant or attorney.
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