Corporate Structures

Business Structures: LLCs, PCs and More

Choosing the right business format is a critical step in establishing your business venture. Each structure has unique features, from tax implications to liability protections, that can significantly impact your operations and goals.

A sole proprietorship is the simplest and least expensive business structure to create and operate. As the owner, you report profits or losses on your personal tax return and bear full personal liability for business debts. This format requires no formal corporate maintenance.

In a general partnership, all partners share personal liability for business debts and report profits or losses on their personal tax returns. Partnerships are simple and inexpensive to establish and operate. One key advantage is that general partners can use their personal resources or obtain financing based on their credit and assets without turning to external investors. This avoids diluting control or ownership, which would happen with external investors.

A limited partnership creates two kinds of business owners. Limited partners are those who do not participate in management. They have limited liability for business debt, but they receive returns, similar to dividends, on their investment. The second kind of owner, general partners, remain personally liable for business debts. While more expensive to set up than a general partnership, this structure is common among real estate companies.

A limited liability company provides owners the same protection from personal liability as a limited partnership. However, it also offers the option of partnership taxation. As a partnership, the LLC receives pass-through tax treatment, meaning that profits and losses are reported on the members’ individual tax returns, thus avoiding the double taxation that corporations often face. (If the LLC instead chooses to operate as a corporation (either a C corporation or an S corporation), this benefit is lost. Although creating an LLC is more expensive than forming a sole proprietorship or partnership, an LLC is easier to maintain than a corporation.

A professional limited liability company offers the same advantages as an LLC, with additional benefits for state-licensed professionals. Members, who must belong to the same profession, are not personally liable for the malpractice of other members, though they remain liable for their own acts of malpractice. PLLCs receive pass-through tax treatment by default; however, single-member PLLCs are treated as sole proprietorships, while multi-member PLLCs are treated as partnerships unless they elect corporate status. This entity type is not available in all states.

A C corporation provides limited liability for its owners. Owners may take salaries or wages (which are deductible business expenses for the corporation) or dividends (which are not deductible business expenses). Owners may also balance how much income they take as salaries and instead leave profits in the corporation. This flexibility can help optimize individual taxation, particularly when individual income tax rates are higher than the corporate rate. C corporations can have an unlimited number of shareholders, and shares of stock can be sold to raise capital. However, they are more expensive to establish and require shareholder meetings to maintain corporate status.

Professional corporations are similar to C corporations but tailored for professionals in the same field. Owners are not liable for the malpractice of others but are liable for their own. Like a C corporation, this structure offers taxation benefits and requires meetings, minutes and reports to maintain corporate status.

S corporations combine limited liability for owners with pass-through taxation. Owners report their share of profits or losses on personal tax returns, and income is allocated according to ownership percentages. This structure allows shareholders to use corporate losses to offset income from other sources (e.g., wages or investments), reducing their overall tax liability. S corporations are more expensive to create and require greater formality than LLCs.

A nonprofit organization serves charitable, educational, religious or scientific purposes. Donors to NPOs enjoy tax-deductible giving. Formalities include annual meetings, reports and minutes. Property transferred to a nonprofit remains with the nonprofit and, if that nonprofit is dissolved, must be passed to another nonprofit.

This overview does not cover all the details and complexities of business structure, so consulting with business counselors, attorneys and accountants is highly recommended. While conversion to a different structure is possible at a later date, it may result in tax consequences or unintended dissolution.

Pro Tip: Equity Compensation

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Business owners often want to give some sort of equity compensation to their most vital staff members. While this is a wonderful sentiment, there are considerations before you take that step:

1. Corporate Structure – this can impact the way in which an equity interest can be bestowed

2. Tax implications for the current owner, the company and the employee

3. Future implications for things like profits distributions, decision making process and succession planning

4. Legal for the transaction and operating agreement moving forward

Using equity compensation can be a valuable tool, if done well.

Fringe Benefits and S-Corps

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As the IRS explains, a 2% shareholder is someone who directly or indirectly owns more than 2% of the corporation’s stock or stock with more than 2% of the voting power. The business must treat a 2% shareholder as a a partner in a partnership for fringe benefit purposes. What does this mean for life insurance?

Generally, life insurance isn’t group-term life insurance unless you provide it at some time during the calendar year to at least 10 full-time employees.

Basically, according to the IRS, businesses must count employees who choose not to receive the insurance as if they do receive insurance, unless, to receive it, they must contribute to the cost of benefits other than the group-term life insurance. For example, businesses must count an employee who could receive insurance by paying part of the cost, even if that employee chooses not to receive it. However, they could not count an employee who chooses not to receive insurance if the employee must pay part or all of the cost of permanent benefits in order to obtain group-term life insurance.

Even businesses that don’t meet the 10-employee rule may fall under one of two exceptions that allow them to treat insurance as group-term life insurance.

Under the first exception, they don’t have to meet the 10-employee rule if all the following conditions are met.

If evidence that the employee is insurable is required, it is limited to a medical questionnaire (completed by the employee) that doesn’t require a physical.
The company provides the insurance to all full-time employees or, if the insurer requires the evidence mentioned in (1), to all full-time employees who provide evidence the insurer accepts.
The company figures the coverage based on either a uniform percentage of pay or the insurer’s coverage brackets that meet certain requirements.

Under the second exception, companies don’t have to meet the 10-employee rule if all the following conditions are met.

They provide the insurance under a common plan covering your employees and the employees of at least one other employer who isn’t related.
The insurance is restricted to, but mandatory for, all employees who belong to, or are represented by, an organization (such as a union) that carries on substantial activities besides obtaining insurance.
Evidence of whether an employee is insurable doesn’t affect an employee’s eligibility for insurance or the amount of insurance that employee gets.

These are just the basics. Consult a professional for further details.

Exclusion from wages

Companies can generally exclude the cost of up to $50,000 of group-term life insurance coverage from the wages of an insured employee. They can exclude the same amount from the employee’s wages when figuring social security and Medicare taxes. In addition, they don’t have to withhold federal income tax or pay FUTA tax on any group-term life insurance provided to an employee.

Coverage over the limit

Companies must include in employees’ wages the cost of group-term life insurance beyond $50,000 worth of coverage, reduced by the amount an employee paid toward the insurance. They must report it as wages in boxes 1, 3, and 5 of the employee’s Form W-2. Also, they should show it in box 12 with code C. The amount is subject to Social Security and Medicare taxes, and employers may, at their option, withhold federal income tax.

Companies should figure the monthly cost of the insurance to include in the employee’s wages by multiplying the number of thousands of dollars of all insurance coverage over $50,000 (figured to the nearest $100) by the cost shown in the table blow For all coverage provided within the calendar year, employers should use the employee’s age on the last day of the employee’s tax year. They must prorate the cost from the table if less than a full month of coverage is involved.

Cost Per $1,000 of Protection for 1 Month

Age

Cost

Under 25

$ 0.05

25 through 29

0.06

30 through 34

0.08

35 through 39

0.09

40 through 44

0.10

45 through 49

0.15

50 through 54

0.23

55 through 59

0.43

60 through 64

0.66

65 through 69

1.27

70 and older

2.06

Companies should figure the total cost to include in the employee’s wages by multiplying the monthly cost by the number of months’ coverage at that cost.

The IRS provides an example: Tom’s employer provides Tom with group-term life insurance coverage of $200,000. Tom is 45 years old, isn’t a key employee, and pays $100 per year toward the cost of the insurance. Tom’s employer must include $170 in Tom’s wages. The $200,000 of insurance coverage is reduced by $50,000. The yearly cost of $150,000 of coverage is $270 ($0.15 x 150 x 12), and is reduced by the $100 Tom pays for the insurance. The employer includes $170 in boxes 1, 3, and 5 of Tom’s Form W-2. The employer also enters $170 in box 12 with code C.

Again, this is a complicated situation, and companies are urged to get professional advice.

Alternative Business Structures That Might Be Right for Your Comp

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Since the start of the COVID-19 pandemic, many aspects of business have changed, including (in some sectors) the increasing availability of private equity, the burgeoning use of AI, the ongoing difficulties in finding talented personnel and the shifting of generational goals and ideals. There are many ways that businesses can respond. One way is to change to an alternative business structure. Professional partnerships, for example, are one way to remain profitable and sustainable.

Alternatives to traditional business models such as sole proprietorships, S corporations, C corporations, partnerships and limited liability companies, include the following.

Split-ups. Instead of remaining one entity, a company may consider splitting into separate businesses. For example, a company that manufactures both men’s and women’s clothing could choose to operate as two separate companies, one for each gender. Some companies split their organization because one portion of the business is regulated and the other is not. Private equity companies are among those that may be attracted to businesses that take this route, either because the investors are interested in just one portion of the business or because regulations prevent them from investing in the entire venture.
Employee stock ownership plans. ESOPs are defined benefit plans that have been around for decades and are currently enjoying a renaissance. Essentially, ESOPs are trust funds funded by the business. They can be set up in one of three ways: The employees own the entire company or have a majority or minority stake in it. All eligible participants receive a compensation-based percentage each year, and that percentage is the same for everyone, from the CEO to the cleaning crew. While ESOPs are not right for all businesses, they give eligible employees a stake in the business, which often fosters loyalty and engagement.
Benefit corporations. B corps are for-profit entities created to make a social impact on society by merging the traditional for-profit business model with a nonprofit model. In other words, B corps take a public interest (for example, in the environment) into consideration before making business decisions; maximizing shareholder wealth is not their only business goal. But not all states recognize B corps; additionally, proving social benefit can be a lengthy process. Companies in states that recognize B corps should be sure to register with the state so they can use the designation in marketing and promotional materials.

Moving to a new business model is not the best answer for every company, but if your company wants to consider a change, consulting with professional advisers, including tax advisers, is important. Changing a business structure is complicated, and business owners need to educate themselves about the tax and regulatory implications and be sure the change aligns with the business’s strategic goals, culture, risk tolerance, technological capabilities and other needs.