1.

Method of Formation of Entity

Few requirements; must only obtain necessary business licenses.

Partnership agreement (written agreement only required for limited partnerships).

Filing of articles of incorporation; must qualify to do business in appropriate states.

Generally same as C Corporation; must also file election with IRS and in some cases (but not with NC) with state to be taxed as an S corporation.

Articles of organization filed in states recognizing LLCs.  An operating agreement is usually required.

2.

Liability

Unlimited personal liability for debts of business.

General partners are jointly and severally liable, limited partners’ liability generally limited to capital contributions.

Shareholders’ liability limited to amount of capital contributions and to debts personally guaranteed, if any.

Same as C corporation.

Same as C corporation.

3.

Management of Business

Proprietor is responsible for all management decisions.

General partners can engage in active management of business; limited partners lose limited liability if actively involved in management.

Management and control is centralized in board of directors; shareholders can actively participate in management as officers and directors.

Same as C corporation.

May be vested in members or elected managers.

4.

Ability to Transfer Interests in Entity

Unrestricted; must, however, transfer assets of business and not an equity interest.

General partner can only transfer his interest with approval of all partners (unless agreement provides otherwise); limited partners may typically transfer interests only with consent of general partners.

Generally unrestricted unless there is an agreement to the contrary.

Same as C corporation, but can only transfer to eligible shareholder if S election is to be retained.

Generally requires unanimous consent.

5.

Tax rules governing formation

No gain or loss recognized on the formation of the business.

Generally, no gain or loss is recognized on contribution of property to partnership in exchange for a partnership interest.

Generally, no gain or loss on transfer of money or property in exchange solely for stock if after transfer the transferors control the corporation.

Same as C corporation.

Same as partnership.

6.

Limitations on ownership

Limited to one individual owner.  (Note: Husband and wife owners are considered a partnership).

No restrictions on who can be an owner, but need at least two members and at least one must be a general partner.

No limitations on the type or number of owners who can hold stock.

Limited to 75 shareholders (husband and wife are counted as one); only individuals, estates, certain trusts, and certain S corporations; can only have one class of stock.

Same as C corporation.

7.

Selection of Taxable Year

Same as tax year of owner.

Generally tax year providing least opportunity to defer income to partners, unless the partnership can show a business purpose for a different year end or files a Section 444 election.

Generally free to adopt any year end it wishes with original return; personal service corporation generally required to use a calendar year end.

Generally required to use a calendar year end, unless it can show a business purpose for a different year end or files a Section 444 election.

Same as partnership

8.

Accounting methods/ Eligibility to use cash method (certain other restrictions apply)

Generally eligible to use the cash method, accrual method, or any other method authorized by the code.

May use the cash method unless it is a tax shelter or has a C corporation as a partner and its average annual gross receipts exceed $5 million.

Required to use the accrual method unless it is a qualified personal service corporation or its annual average gross receipts are less than $5 million.

Same as sole proprietorship unless it is a tax shelter.

Same as partnership.

9.

Entity level taxation

Not treated as a separate entity for tax purposes.

Partnership itself is not a separate tax-paying entity.  Items of income, loss, etc. are passed through to owners.

Entity-level tax is imposed on corporation’s taxable income.

Generally not subject to corporate-level taxes; exceptions apply to C corporations that convert to S status.

Same as partnership.

10.

Allocation of Profits and Losses

Allocated entirely to sole owner.

Flexibility in allocating items of income, loss, etc. so long as allocations have substantial economic effect.

No allocation issue because items of income and loss do not pass through to shareholders.

Items of income or loss allocated to shareholders on a daily per-share basis.

Same as partnership.

11.

Limits on utilization of losses

Losses reported directly on owner’s individual return subject to certain limits including hobby-loss rules, at-risk rules, and passive activity rules.

Potential limitations include basis limitation, at-risk rules, and passive activity loss rules.  Basis can (but not always) include partnership debt to third parties.

Only corporation can utilize losses by either carrying them back or forward;  closely held C corporations are also limited by the at-risk and passive activity rules (in modified form).  Personal service corporations are fully subject to passive loss rules.

Shareholders may use losses but are subject to same rules as partnership except that third party debt cannot be included in basis.

Same as partnership.

12.

Tax treatment of cash distributions

No tax on cash withdrawn from business.

Partners taxed only on cash distributions in excess of partner’s basis in partner’s partnership interest.  Generally such distributions are considered capital gains.

Dividends to shareholders are taxed as ordinary income if they do not exceed the corporations AE&P; corporate shareholders should qualify for a partial dividends received deduction.

Cash distributions to shareholders tax-free if S corporation has AE&P and distribution does not exceed shareholder’s stock basis;  distributions in excess of shareholder’s stock basis are reported as capital gain.  Distributions taxable as dividends if out of AE&P.

Same as partnership.

13.

Tax treatment of property distributions

Generally no tax on withdrawal of property from business.

Generally no gain or loss on distribution of property other than money to a partner.  See, however Sections 704(C)(1)(B) and 737.

Corporation generally recognizes gain on distributions of appreciated property.  Transaction treated as if corporation sold the property for its fair market value.  Shareholder generally reports receipt of property as taxable dividend.

Corporation generally recognizes gain on distributions of appreciated property, gain passes through to shareholders.  Transaction treated as if corporation sold the property for its fair market value.  Distributions are generally tax-free to shareholders depending upon the corporation’s AAA, AE&P, and the shareholder’s basis in the stock.

Same as partnership.

14.

Sale of interest in entity

Cannot sell equity interest; sale of business viewed as a sale of each asset.

Partner can sell interest in partnership; gain or loss is generally capital unless ordinary income assets or Section 736 payments are involved.  Some of capital gain may be subject to 25% capital gain rate.

Shareholder who sells stock generally has a capital gain or loss; sale of Section 1244 stock may result in ordinary loss and 50% of gain on sale of qualified small business stock may be excluded from tax.

Generally same as for C corporation, except no exclusion available for gain on sale of stock and some of gain may be subject to 25% capital gains rate.

Same as partnership.

15.

Sale of assets of entity

Recognize gain or loss separately on each asset sold.

Gains or losses from sale passed through and taxed once at partner level.

Corporate level tax is imposed on gains and losses recognized on sale of assets. A shareholder level tax is also imposed when sale proceeds are distributed.

Gain or loss on sale of asset passes through to the shareholders and therefore only taxed once unless corporation is subject to special corporate level tax.

Same as partnership.

16.

Redemption of interest in entity

Redemption principles do not apply.

For rules regarding partial redemption, see numbers 12 and 13 previously; special rules apply to distributions in retirement of a partner’s entire partnership interest.

Distributions in redemption of shareholder’s stock is not deductible by the corporation and is treated as a dividend to shareholder, unless an exception applies which qualifies the redemption for sale or exchange treatment.

Treatment depends upon whether redemption is considered a dividend or a sale or exchange.  If a sale or exchange, capital gain recognized if distribution exceeds shareholder’s basis.  If dividend see rules 12 and 13 previously.

Same as partnership.

17.

Liquidation of entity

N/A, business ends when owner ceases to conduct business.

Partnership and partners generally recognize no gain or loss on an in-kind liquidating distribution; partners recognize gain to the extent they receive money (including debt relief) in excess of basis in their partnership interest.

Corporation generally recognizes gain or loss as if it sold the assets at fair market value; shareholder generally recognizes gain to extent value of assets received in liquidation exceed stock basis; generally recognize capital loss if value of property received is less than shareholder’s stock basis.  Loss is ordinary to the extent Section 1244 applies.

Same as C corporation except that corporate gain on liquidation passes through to shareholders and thus is only taxed once (unless corporation level tax applies – limited to former C corporations).

Same as partnership.

18.

Source of equity capital

Owner contributions.

Generally can have unlimited number of partners with different economic interests.

Unrestricted.

Limited to a single class of stock, 75 shareholders, and generally only individual shareholders.

Same as partnership.

19.

Salary to Owners

N/A

N/A, although guaranteed payments are allowed they are not considered salary or wages and are generally not subject to withholding.

Must be reasonable in amount to be deducted by corporation.

Same as C corporation.  A reasonable salary must be paid to the owner-employee or IRS can reclassify distributions to salary.

Same as partnership.

20.

Qualified retirement plans

Generally subject to limitations applicable to all taxpayers.  ESOP not available. Loan from plan to owner may be prohibited transaction.

Same as sole proprietorship.

Generally subject to limitations applicable to all taxpayers.

Same as sole proprietorship.

Same as sole proprietorship.

21.

Medical insurance, fringe benefits, etc.

Generally no deduction to sole proprietor except to the extent individual qualifies for the partial deduction for medical insurance premiums.

Generally cannot be provided on a tax-free basis to partners.  Partner may be entitled to a partial deduction of the medical insurance premiums.

Generally deductible to corporation and tax-free to shareholder-employee if non-discrimination rules are satisfied.

Treatment of more than 2% shareholders generally the same as for partners.

Same as partnership.