S Corp Partnership: Everything You Need to Know
An S corp partnership is possible and when an individual launch a business it can be an S corporation, a C corporation, an LLC or a sole proprietorship.3 min read
2. S Corporation v. Partnership
An S corp partnership is possible. In fact, an individual launching a business can be an S corporation, a C corporation, an LLC or a sole proprietorship. When two people launch a business, they can form a partnership, an LLC, an S Corporation or a C corporation.
Choosing a Business Entity Type
When deciding on business form, you should consider both state law and tax matters when determining the form for your business. Note as follows:
- A general partner has unlimited liability for business debts.
- To avoid liability, you can form a limited partnership, or LP, provided that there is at least one general partner and one limited partner.
- In such an instance, a general partner has unlimited liability while a limited partner will have liability to the extent of his or her contribution to the partnership.
- A partnership may contain different classes of partners and is provided flexibility with respect to allocating profits and losses to the various sets of partners.
- Liabilities may increase based on a partner's portion in the partnership, which can offset cash distributions and reduce taxation.
- A partner who contributes appreciated property to a partnership is generally not liable for tax on the contribution, even if that partner is not a controlling partner.
- A corporation will have limited liability.
- A shareholder, in general, will not be responsible for corporate liabilities outside of his or her contributions to the corporation.
Concurrently, it is very important to consider federal tax obligations and consequences when choosing a form of business entity.
- A significant concern is avoiding a double taxation, wherein business income is taxed on the corporate level and employees and shareholders pay tax on a personal level.
- To avoid this tax liability, create a form that is taxed as pass-through entity, which can be an S corporation or a partnership.
- Pass-through means that business income is not taxed at the corporate level and instead “passes through” to shareholders or partners, depending on the entity, and is then taxed at each individual’s personal rate.
- C corporations, in contrast, are subject to double taxation taxable entities.
- Note that income of a pass-through business entity is taxable to its shareholders or partners, regardless of whether the shareholder or partner actually received a distribution.
- Dividends, in contrast to income, are taxed only when an actual distribution occurs.
- State law governs organizing a partnership whereas the federal tax system governs an S corporation.
- In respect of state law, an S corporation has regular corporation status.
- In terms of distributing shares, an S corporation is limited to 100 shareholders with only specific individuals, estates, and trusts as eligible shareholders.
- In terms of eligibility, a C corporation or a nonresident alien are barred from being a shareholder in an S corporation.
- S corporation stock is capped at a single class of stock.
- Any income or loss is allocated on a pro rata basis to all shareholder.
- Note that having just one class of stock can affect the S corporation's ability to raise capital.
S Corporation v. Partnership
Forming a partnership is relatively easy in that it has no paperwork requirement. In fact, partnership creation can occur without intention. This happens when two people start working in a business together.
On the other hand, an S corporation has complex registration requirements:
- First, the business is to register as a corporation (S or C) or as an LLC in the state where it primary performs its business. This usually requires drafting an articles of incorporation document or an articles of organization document.
- Second, once submitted, the company is to complete and file an IRS Form 2553, which makes an S corporation election.
Partnerships, as opposed to S corporations, have flexibility with respect to company structure in regard to both management and p & l allocation. Regarding management, the default rule is that all partners have equal say notwithstanding share of ownership. The partnership is flexible to create a structure that has other management arrangements. For instance, the partners agree that one partner will be the managing partner. Another example is partners create a system of different shares of p & l notwithstanding ownership interest.
For S corporations, shareholders elect a board of directors, which is tasked to oversee company management, including appointing officers to oversee daily operations of the company. There is no flexibility regarding profits and losses. Those are per shares owned.
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