The law recognizes two types of persons: the natural kind, like you and me who eat three meals a day, sleep through alarm clocks, etc.; and the artificial kind which are legal entities created to perform a specific task. Imagine our economy without corporations, partnerships, trusts, decedents’ estates, and the like; how would anything get done?
Each of these entities has evolved for a specific purpose, and most relate directly to commercial transactions. Perhaps the oldest of them all is the partnership which is nothing more than the association of two or more people for an agreed purpose; the problem with a partnership, as it has evolved, is that the individual partners can be personally liable for the debts of a venture. To eliminate that problem, well over 100 years ago the corporation was born; legislatures provided that people could incorporate and avoid personal liability for debts of a business venture provided they met certain criteria, foremost of which is the obligation to let the world know that liability is limited. Generally speaking, the structure of a corporation is more formal than that of a partnership in that there are directors, officers, and shares of stock, none of which are generally associated with partnerships. To complicate matters further, the entities usually receive different tax treatment, and generally, partnership tax treatment is preferential to that of a corporation; shareholders have often chosen to pay higher taxes just to obtain the corporate protection from personal liability.
But this isn’t America for nothing! If the partnership is at one end of the spectrum and the corporation is at the other, ever-resourceful lawyers, accountants, and legislators have been busy inventing all manner of entities in-between, hybrids of sorts. First there was the limited partnership, then the business trust, the professional association, and most recently the limited liability partnership (the “LLP”) and the limited liability company (the “LLC”). Each of these entities, and there are still others, has been invented for one or more specific purposes, and very often the purpose is to save taxes. They borrow characteristics from each other in an effort to gain the advantages of both worlds.
When a partnership has two equal partners and makes a $100 profit, $50 of the income is taxed to each partner. When an ordinary corporation has a $100 profit, it pays taxes on the income at a rate that is generally higher than individual rates under both state and federal tax codes; after paying its taxes, the corporation then pays what’s left to the shareholders who then must pay tax on the income personally. This is the so-called double taxation. Effectively, legislators have said, for your shield against liability Mr. Shareholder, you are going to pay a premium.
So, the limited partnership was born where the limited partners have protection against personal debts of the venture, but are taxed as individuals. But there are a couple of problems; for one, every limited partnership must have a general partner who is liable personally for its debts. Okay, we’ll create a shell corporation with few assets to be the general partner, and the rest of us will be limited partners. Perfectly legal. But, says the Internal Revenue Code, to qualify for partnership taxation, the “shell” general partner must have substantial assets, often to an extent which makes it impractical.
Recognizing the problem (somewhat) Congress created the “S-corporation”. Originally it said that if a corporation had no more than ten shareholders and several other limitations, effectively it could be taxed as a partnership (i.e., the income would flow directly to the shareholders for tax purposes and the corporation would pay no taxes). It was less than perfect, but it helped many small business, and gradually Congress has relaxed the rules (e.g., there can now be up to 75 shareholders) making it even more useful.
Still we needed something more and thus the creation of the LLP and the LLC; virtually all of the states have passed legislation creating them. The LLP in Pennsylvania has been created for very specialized purposes, but the LLC is much broader in its application. The LLC would have it all! All “partners” would be shielded against the debts of the venture, and it would look just like a corporation; but its “shareholders” would be taxed as partners. Well, not quite. The Internal Revenue Service was quick to rule that it would receive partnership treatment, but the Pennsylvania legislature said “whoa”, irrespective of federal treatment in Pennsylvania you are a corporation for tax purposes. This was several years back, and as a result the Pennsylvania LLC was put on a back shelf to collect dust.
That is until now! This past May, a bill was enacted, and for the first time it appears that most LLC’s will be taxable at both the federal and state levels as partnerships in which the owners will not be personally liable for a venture’s debts. It is too recent to be certain, but it looks promising and may well become the entity of choice for many small businesses.
Hold on, that’s not the end of it. New life has recently been breathed into the limited partnership as well. The Internal Revenue Service has relaxed the capital requirements for a corporate general partner. This creates considerably more flexibility with this business form, and if it were not for the LLC, this probably would be the entity of choice and still might be best under certain circumstances.
Had enough? Legislative change remains the order of the day. Just about every time Congress gets together it seems it further relaxes the S-corporation rules, and 1996 was no exception. And you can bet that as you read Congress is tampering further, so that the ordinary corporation with which we are all familiar may yet prevail as the favored entity.
If you are a small business person, slugging it out daily with the challenges of the market place, at least in one area, the burdens have eased. We welcome the options.
Each of these entities has evolved for a specific purpose, and most relate directly to commercial transactions. Perhaps the oldest of them all is the partnership which is nothing more than the association of two or more people for an agreed purpose; the problem with a partnership, as it has evolved, is that the individual partners can be personally liable for the debts of a venture. To eliminate that problem, well over 100 years ago the corporation was born; legislatures provided that people could incorporate and avoid personal liability for debts of a business venture provided they met certain criteria, foremost of which is the obligation to let the world know that liability is limited. Generally speaking, the structure of a corporation is more formal than that of a partnership in that there are directors, officers, and shares of stock, none of which are generally associated with partnerships. To complicate matters further, the entities usually receive different tax treatment, and generally, partnership tax treatment is preferential to that of a corporation; shareholders have often chosen to pay higher taxes just to obtain the corporate protection from personal liability.
But this isn’t America for nothing! If the partnership is at one end of the spectrum and the corporation is at the other, ever-resourceful lawyers, accountants, and legislators have been busy inventing all manner of entities in-between, hybrids of sorts. First there was the limited partnership, then the business trust, the professional association, and most recently the limited liability partnership (the “LLP”) and the limited liability company (the “LLC”). Each of these entities, and there are still others, has been invented for one or more specific purposes, and very often the purpose is to save taxes. They borrow characteristics from each other in an effort to gain the advantages of both worlds.
When a partnership has two equal partners and makes a $100 profit, $50 of the income is taxed to each partner. When an ordinary corporation has a $100 profit, it pays taxes on the income at a rate that is generally higher than individual rates under both state and federal tax codes; after paying its taxes, the corporation then pays what’s left to the shareholders who then must pay tax on the income personally. This is the so-called double taxation. Effectively, legislators have said, for your shield against liability Mr. Shareholder, you are going to pay a premium.
So, the limited partnership was born where the limited partners have protection against personal debts of the venture, but are taxed as individuals. But there are a couple of problems; for one, every limited partnership must have a general partner who is liable personally for its debts. Okay, we’ll create a shell corporation with few assets to be the general partner, and the rest of us will be limited partners. Perfectly legal. But, says the Internal Revenue Code, to qualify for partnership taxation, the “shell” general partner must have substantial assets, often to an extent which makes it impractical.
Recognizing the problem (somewhat) Congress created the “S-corporation”. Originally it said that if a corporation had no more than ten shareholders and several other limitations, effectively it could be taxed as a partnership (i.e., the income would flow directly to the shareholders for tax purposes and the corporation would pay no taxes). It was less than perfect, but it helped many small business, and gradually Congress has relaxed the rules (e.g., there can now be up to 75 shareholders) making it even more useful.
Still we needed something more and thus the creation of the LLP and the LLC; virtually all of the states have passed legislation creating them. The LLP in Pennsylvania has been created for very specialized purposes, but the LLC is much broader in its application. The LLC would have it all! All “partners” would be shielded against the debts of the venture, and it would look just like a corporation; but its “shareholders” would be taxed as partners. Well, not quite. The Internal Revenue Service was quick to rule that it would receive partnership treatment, but the Pennsylvania legislature said “whoa”, irrespective of federal treatment in Pennsylvania you are a corporation for tax purposes. This was several years back, and as a result the Pennsylvania LLC was put on a back shelf to collect dust.
That is until now! This past May, a bill was enacted, and for the first time it appears that most LLC’s will be taxable at both the federal and state levels as partnerships in which the owners will not be personally liable for a venture’s debts. It is too recent to be certain, but it looks promising and may well become the entity of choice for many small businesses.
Hold on, that’s not the end of it. New life has recently been breathed into the limited partnership as well. The Internal Revenue Service has relaxed the capital requirements for a corporate general partner. This creates considerably more flexibility with this business form, and if it were not for the LLC, this probably would be the entity of choice and still might be best under certain circumstances.
Had enough? Legislative change remains the order of the day. Just about every time Congress gets together it seems it further relaxes the S-corporation rules, and 1996 was no exception. And you can bet that as you read Congress is tampering further, so that the ordinary corporation with which we are all familiar may yet prevail as the favored entity.
If you are a small business person, slugging it out daily with the challenges of the market place, at least in one area, the burdens have eased. We welcome the options.
The law recognizes two types of persons: the natural kind, like you and me who eat three meals a day, sleep through alarm clocks, etc.; and the artificial kind which are legal entities created to perform a specific task. Imagine our economy without corporations, partnerships, trusts, decedents’ estates, and the like; how would anything get done?
Each of these entities has evolved for a specific purpose, and most relate directly to commercial transactions. Perhaps the oldest of them all is the partnership which is nothing more than the association of two or more people for an agreed purpose; the problem with a partnership, as it has evolved, is that the individual partners can be personally liable for the debts of a venture. To eliminate that problem, well over 100 years ago the corporation was born; legislatures provided that people could incorporate and avoid personal liability for debts of a business venture provided they met certain criteria, foremost of which is the obligation to let the world know that liability is limited. Generally speaking, the structure of a corporation is more formal than that of a partnership in that there are directors, officers, and shares of stock, none of which are generally associated with partnerships. To complicate matters further, the entities usually receive different tax treatment, and generally, partnership tax treatment is preferential to that of a corporation; shareholders have often chosen to pay higher taxes just to obtain the corporate protection from personal liability.
But this isn’t America for nothing! If the partnership is at one end of the spectrum and the corporation is at the other, ever-resourceful lawyers, accountants, and legislators have been busy inventing all manner of entities in-between, hybrids of sorts. First there was the limited partnership, then the business trust, the professional association, and most recently the limited liability partnership (the “LLP”) and the limited liability company (the “LLC”). Each of these entities, and there are still others, has been invented for one or more specific purposes, and very often the purpose is to save taxes. They borrow characteristics from each other in an effort to gain the advantages of both worlds.
When a partnership has two equal partners and makes a $100 profit, $50 of the income is taxed to each partner. When an ordinary corporation has a $100 profit, it pays taxes on the income at a rate that is generally higher than individual rates under both state and federal tax codes; after paying its taxes, the corporation then pays what’s left to the shareholders who then must pay tax on the income personally. This is the so-called double taxation. Effectively, legislators have said, for your shield against liability Mr. Shareholder, you are going to pay a premium.
So, the limited partnership was born where the limited partners have protection against personal debts of the venture, but are taxed as individuals. But there are a couple of problems; for one, every limited partnership must have a general partner who is liable personally for its debts. Okay, we’ll create a shell corporation with few assets to be the general partner, and the rest of us will be limited partners. Perfectly legal. But, says the Internal Revenue Code, to qualify for partnership taxation, the “shell” general partner must have substantial assets, often to an extent which makes it impractical.
Recognizing the problem (somewhat) Congress created the “S-corporation”. Originally it said that if a corporation had no more than ten shareholders and several other limitations, effectively it could be taxed as a partnership (i.e., the income would flow directly to the shareholders for tax purposes and the corporation would pay no taxes). It was less than perfect, but it helped many small business, and gradually Congress has relaxed the rules (e.g., there can now be up to 75 shareholders) making it even more useful.
Still we needed something more and thus the creation of the LLP and the LLC; virtually all of the states have passed legislation creating them. The LLP in Pennsylvania has been created for very specialized purposes, but the LLC is much broader in its application. The LLC would have it all! All “partners” would be shielded against the debts of the venture, and it would look just like a corporation; but its “shareholders” would be taxed as partners. Well, not quite. The Internal Revenue Service was quick to rule that it would receive partnership treatment, but the Pennsylvania legislature said “whoa”, irrespective of federal treatment in Pennsylvania you are a corporation for tax purposes. This was several years back, and as a result the Pennsylvania LLC was put on a back shelf to collect dust.
That is until now! This past May, a bill was enacted, and for the first time it appears that most LLC’s will be taxable at both the federal and state levels as partnerships in which the owners will not be personally liable for a venture’s debts. It is too recent to be certain, but it looks promising and may well become the entity of choice for many small businesses.
Hold on, that’s not the end of it. New life has recently been breathed into the limited partnership as well. The Internal Revenue Service has relaxed the capital requirements for a corporate general partner. This creates considerably more flexibility with this business form, and if it were not for the LLC, this probably would be the entity of choice and still might be best under certain circumstances.
Had enough? Legislative change remains the order of the day. Just about every time Congress gets together it seems it further relaxes the S-corporation rules, and 1996 was no exception. And you can bet that as you read Congress is tampering further, so that the ordinary corporation with which we are all familiar may yet prevail as the favored entity.
If you are a small business person, slugging it out daily with the challenges of the market place, at least in one area, the burdens have eased. We welcome the options.
Each of these entities has evolved for a specific purpose, and most relate directly to commercial transactions. Perhaps the oldest of them all is the partnership which is nothing more than the association of two or more people for an agreed purpose; the problem with a partnership, as it has evolved, is that the individual partners can be personally liable for the debts of a venture. To eliminate that problem, well over 100 years ago the corporation was born; legislatures provided that people could incorporate and avoid personal liability for debts of a business venture provided they met certain criteria, foremost of which is the obligation to let the world know that liability is limited. Generally speaking, the structure of a corporation is more formal than that of a partnership in that there are directors, officers, and shares of stock, none of which are generally associated with partnerships. To complicate matters further, the entities usually receive different tax treatment, and generally, partnership tax treatment is preferential to that of a corporation; shareholders have often chosen to pay higher taxes just to obtain the corporate protection from personal liability.
But this isn’t America for nothing! If the partnership is at one end of the spectrum and the corporation is at the other, ever-resourceful lawyers, accountants, and legislators have been busy inventing all manner of entities in-between, hybrids of sorts. First there was the limited partnership, then the business trust, the professional association, and most recently the limited liability partnership (the “LLP”) and the limited liability company (the “LLC”). Each of these entities, and there are still others, has been invented for one or more specific purposes, and very often the purpose is to save taxes. They borrow characteristics from each other in an effort to gain the advantages of both worlds.
When a partnership has two equal partners and makes a $100 profit, $50 of the income is taxed to each partner. When an ordinary corporation has a $100 profit, it pays taxes on the income at a rate that is generally higher than individual rates under both state and federal tax codes; after paying its taxes, the corporation then pays what’s left to the shareholders who then must pay tax on the income personally. This is the so-called double taxation. Effectively, legislators have said, for your shield against liability Mr. Shareholder, you are going to pay a premium.
So, the limited partnership was born where the limited partners have protection against personal debts of the venture, but are taxed as individuals. But there are a couple of problems; for one, every limited partnership must have a general partner who is liable personally for its debts. Okay, we’ll create a shell corporation with few assets to be the general partner, and the rest of us will be limited partners. Perfectly legal. But, says the Internal Revenue Code, to qualify for partnership taxation, the “shell” general partner must have substantial assets, often to an extent which makes it impractical.
Recognizing the problem (somewhat) Congress created the “S-corporation”. Originally it said that if a corporation had no more than ten shareholders and several other limitations, effectively it could be taxed as a partnership (i.e., the income would flow directly to the shareholders for tax purposes and the corporation would pay no taxes). It was less than perfect, but it helped many small business, and gradually Congress has relaxed the rules (e.g., there can now be up to 75 shareholders) making it even more useful.
Still we needed something more and thus the creation of the LLP and the LLC; virtually all of the states have passed legislation creating them. The LLP in Pennsylvania has been created for very specialized purposes, but the LLC is much broader in its application. The LLC would have it all! All “partners” would be shielded against the debts of the venture, and it would look just like a corporation; but its “shareholders” would be taxed as partners. Well, not quite. The Internal Revenue Service was quick to rule that it would receive partnership treatment, but the Pennsylvania legislature said “whoa”, irrespective of federal treatment in Pennsylvania you are a corporation for tax purposes. This was several years back, and as a result the Pennsylvania LLC was put on a back shelf to collect dust.
That is until now! This past May, a bill was enacted, and for the first time it appears that most LLC’s will be taxable at both the federal and state levels as partnerships in which the owners will not be personally liable for a venture’s debts. It is too recent to be certain, but it looks promising and may well become the entity of choice for many small businesses.
Hold on, that’s not the end of it. New life has recently been breathed into the limited partnership as well. The Internal Revenue Service has relaxed the capital requirements for a corporate general partner. This creates considerably more flexibility with this business form, and if it were not for the LLC, this probably would be the entity of choice and still might be best under certain circumstances.
Had enough? Legislative change remains the order of the day. Just about every time Congress gets together it seems it further relaxes the S-corporation rules, and 1996 was no exception. And you can bet that as you read Congress is tampering further, so that the ordinary corporation with which we are all familiar may yet prevail as the favored entity.
If you are a small business person, slugging it out daily with the challenges of the market place, at least in one area, the burdens have eased. We welcome the options.
– Ken Butera