BUSINESS ENTITIES, GENERAL INFO, & PLANNING©
BUSINESS ENTITIES OVERVIEW:
C Corporations | PSC Corporations | Sub S Corporations | Limited Liability Companies (LLC)Nevada Corporations & LLCs | Partnerships
The Meaning of C, Sub S and PSC Corporation Classifications
There are no C, S and PSC distinctions upon formation of a corporation at the state capitol, and the designations have nothing to do with the legal structure of the corporation provided by the state of incorporation. The "letter" designations are federal tax law terms which refer to how the corporation is treated under federal tax laws. Federal tax law does cause a difference in how the three types of corporations may be structured. These letter designations mainly affect tax and stock/shareholder issues. Otherwise C, PSC and S corporations are identical. All corporations are automatically a C type under Federal tax law unless a special S election is filed or PSC treatment is selected with the IRS. The tax and stock/shareholder issues are explained below.
C Corporations
Major advantages are limited liability, the efficiency with which it handles a large number of shareholders, the ease and legality of buying and selling its stock. Owners of the corporation may receive all legal employee benefits, and have the benefits be tax deductible to the corporation. The stock of a C corporation can be owned by other business entities as well as by humans. A serious disadvantage is that all profits are taxed at the corporate level, then dividends or profits are taxed to the shareholders, resulting in double taxation of profits. Other disadvantages are the required annual reporting to the state, and annual formalities such as shareholder and directors' meetings, plus lack of privacy and franchise taxes at the state level. (There are also potential capital gains tax problems with this entity which are discussed below.)
PSC Corporations
The letters "PSC" stand for personal service corporations. This corporation type is nearly identical to a C corporation, but with its own special tax rate. It was created for professionals and individuals whose business activity involves the sale of personal services, as opposed to the sale of products or non-personal services. Personal services are those performed in the health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting fields. You "choose" this type corporation by forming a corporation through your state, and then selecting the "Personal Services Corporation" category on the standard IRS form 1120 corporate tax return. This corporate classification is often used by professionals to achieve corporate tax deductible employee benefits for one or more professionals offering personal services. The applicability and usage of the PSC classification is very complicated, and should only be undertaken with the guidance of your professional tax counselor.
Sub S Corporations
The double taxation problem of the C corporation is eliminated, taxes on profits are paid only at the shareholder level. For tax purposes the Sub S corp is referred to as a "pass through" entity, meaning that tax liabilities pass to the shareholders. This is the major reason that Congress created the Sub S corporation status. But there is a limit to the number of shareholders and they generally must be humans. Shares cannot be held by other corporations (either C or Sub S), or by partnerships or LLCs. Trusts may hold Sub S shares but only with special provisions. Major advantages are the pass thru tax status, the ease of buying and selling stock, and the limited liability of the members. Sub S corporations can have deductible employee stock ownership plans (ESOPs) and employee pension plans for both owners and non-owner employees. But many other employee benefits, when given to the owners of the S corporation, are not deductible to the corporation. Some disadvantages are the required annual reporting to the state and annual formalities such as shareholder and directors' meetings, lack of privacy and franchise taxes at the state level. (There are also potential capital gains tax problems with this entity which are discussed below.)
Limited Liability Companies (LLC)
This entity first appeared in Wyoming in 1977. LLCs combine the limited liability feature of corporations with most of the characteristics and advantages of partnerships. The LLC is allowed to have partnership tax classification when there are at least two members. This makes it a pass thru entity for tax purposes. Partnership tax classification is a better arrangement than the pass thru tax status of S corporations (due to the LLCs ability to allocate income, deductions and losses to the owners in any proportion). Unlike the S corporation, any person or legal entity can own its shares (called units), there can be any number of shareholders (called members), all members can vote (unlike limited partners) and there is limited liability for everyone connected with the LLC (unlike partnerships). LLCs can have deductible employee pension plans for both owners and non-owner employees. But many other employee benefits, when given to the owners of the LLC, are not deductible to the LLC. LLCs do not have the capital gains tax problem which corporations do (discussed below). LLCs do require annual reporting to the state where they are created. But no annual shareholder or directors' meetings are required, and other formalities of corporations have been eliminated. Many states do not charge a franchise tax but they all charge some annual registration fee. This is an excellent entity choice for a very wide variety of small business situations, and should be given serious consideration.
Nevada Corporations & LLCs
In earlier decades the state of Delaware was considered to be the best state to form a corporation in. For several reasons the state of Nevada has become the undisputed corporate and LLC haven of the U.S. This does not mean that you can automatically and easily gain the benefits of a Nevada entity when your business operation is in another state. To the contrary, not all non-Nevada based businesses will be able to structure themselves and jump thru the extra hoops that are required to benefit from a Nevada business entity. If you are able to handle the extra requirements, the added benefits of a Nevada entity are:
Better Limited Liability. An extra level of protection afforded by the Nevada corporate and LLC veil (better limited liability provisions in Nevada). Nevada state law and court precedence make the corporate veil all but impossible to pierce, except for criminal fraud. (See the Nevada case, Roland vs. Lepire, 1983) In most instances your non-Nevada business will have to register its Nevada corporation in your home state, but Nevada's tough laws prevail on matters of limited liability of corporate officers, directors and shareholders.
Choice of Governing Law. Choice of governing law means that on most formal and informal contracts and transactions you can specify Nevada as the choice of state law governing the contract or transaction. This places an extra burden of expense on a potential litigant since they will have to travel to Nevada to sue your company. It also forces the lawsuit to be heard under laws that are more pro-business than most states.
Additional Privacy. Nevada has no requirement or procedure to register or list stockholders in public records, thus assuring their privacy. Remember that shareholders control the company and receive its profits. Furthermore, the state of Nevada does not share information with the IRS (per state law). Elimination of state income tax for corporations in a few special situations (see the footnote at the end of this article regarding possible corporate tax savings in Nevada.) If you plan to form either a corporation or an LLC, you may want to consider the added advantages of forming the entity in Nevada. NAFEP provides Nevada entities and all the annual services necessary to keep them legal in Nevada. If you form a Nevada entity, but use it in another state, you must also register the entity in that other state. For non-Nevada businesses, using a Nevada entity does increase your costs by a few hundred dollars each year. The Nevada entity will have annual registration and other costs in two states instead of one.
Partnerships
Partnerships fall into two categories, general and limited. General partnerships have no limited liability for any partner. Limited partnerships have limited liability for the limited partners but not for the general partner (the controlling or operating partner or partners). Lack of limited liability for all partners and owners is a major disadvantage of partnerships. In addition, limited partners have no vote or say in how the business is run. The LLC appears to be a better choice in all cases where a partnership might be considered, and as a result NAFEP does not create partnerships.