Ownership Restrictions Relating to Tax on a Business
When you decide to start a business venture, there are a myriad of things to consider. We regularly assist small business owners, especially start-up businesses, walking them through the steps that need to be taken in order to make the business official and legal. There are many ways a business can be organized and there are both non-tax and tax factors as well as state and local statutory requirements that need to be taken into consideration when embarking on this exciting journey of starting a business.
I previously wrote an article regarding the non-tax factors that should be considered when starting a business. This article is one of a series of articles that focuses on the tax implications of certain business activities and things you should consider when choosing your business entity. The most prominent federal tax considerations in choosing a business entity include:
- Capital Contributions
- Ownership Restrictions
- Business Income and Loss
- Allocations of Income or Loss
- Basis Limitations and the Deductibility of Losses
- Employment Tax Considerations
- Tax Rates on Ordinary Income
This article will address the ownership restrictions relating to corporate tax.
An entity (including a limited liability company) may be treated as a partnership for tax purposes regardless of the nature of the business or the number of members or partners. Thus, the partners or members of the entity may consist of any number of domestic or foreign individuals, corporations, trusts, estates, tax-exempt organizations, or other partnerships. An unincorporated business entity with more than one owner is taxed as a partnership under Subchapter K of the Internal Revenue Code (IRC) unless it elects to be treated as a corporation. Partnerships are not treated as taxable entities but the income, gains, losses, and expenses are pass-through to the partners or members who report those items on their individual tax returns.
Certain joint ventures involving passive property or natural resource extraction may elect to be excluded from Subchapter K rules and be treated as co-ownerships.
There are no restrictions on the nature and number of shareholders of a C corporation. Corporations may engage in any kind of activity permitted by their charters. Taxation under Subchapter C is not elective for any entity that is incorporated under local law. Certain unincorporated entities may elect to be treated as a corporation (i.e., an LLC) by electing to be taxed under Subchapter S of the Internal Revenue Code. The Subchapter S election requires the unanimous consent of all of the corporation’s shareholders.
Subchapter S corporations are subject to important limitations on the number and the kind of shareholders they may have. In order to be able to elect to be taxed under Subchapter S there can be no more than 100 shareholders and all shareholders must be individuals who are US citizens or residents, estates, or certain kinds of trusts. Corporations, associations, partnerships, LLCs, or foreign nationals cannot be shareholders of an S corporation.
Although a C corporation cannot own stock in an S corporation, an S corporation is permitted to have wholly-owned subsidiaries that are C corporations.
For a detailed comparison of the differences between the tax consequences of Subchapter K and Subchapter S click here. For a complete analysis of the tax implications of C Corporations, Partnerships, and S Corporations click here for the Joint Committee on Taxation’s publication entitled “Choice of Business Entity: Present Law and Data Relating to C Corporations, Partnerships, and S Corporations.”
Attorney Angel Oliver / McGrath and Spielberger, PLLC assists clients with all sorts of tax matters, both federal and state (including but not limited to North Carolina and South Carolina). Click here to contact Ms. Oliver about your tax matter.
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