S corporations elect to pass corporate income, losses, deductions, and credit through to their shareholders for federal tax purposes.
Describe the characteristics of an S corporation
- In terms of federal income taxation, S corporations resemble partnerships in that income, deductions, and tax credits flow through annually to shareholders, regardless of whether distributions are made.
- Payments are distributed to S shareholders tax-free to the extent that the distributed earnings were not previously taxed.
- Unlike a C corporation, an S corporation is not eligible for a dividends received deduction, nor is it subject to the ten percent of taxable income limitation applicable to charitable contribution deductions.
- S corporation: a legal designation of companies that elect to pass income, losses, deductions, and credit through to their shareholders for federal tax purposes
- shareholder: One who owns shares of stock.
- C Corporations: any corporation that, under United States federal income tax law, is taxed separately from its owners
- dividends: Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders.
S corporations elect to pass corporate income, losses, deductions, and credit through to their shareholders for federal tax purposes. S status combines the legal environment of C corporations with partnership-like federal income taxation.
Like a C corporation, an S corporation is generally subject to the laws of the state in which it is organized. However, in the manner of a partnership, an S corporation’s income, deductions, and tax credits flow through annually to shareholders, regardless of whether distributions are made. Thus, income is taxed at the shareholder level and not at the corporate level, and payments are distributed to S shareholders tax-free to the extent that the distributed earnings were not previously taxed.
Certain corporate penalty taxes (e.g., accumulated earnings tax, personal holding company tax) and the alternative minimum tax do not apply to an S corporation. Unlike a C corporation, an S corporation is not eligible for a dividends received deduction, nor is it subject to the ten percent of taxable income limitation applicable to charitable contribution deductions.
In order to be eligible for S corporation status, a corporation must meet certain requirements:
- Be an eligible entity (a domestic corporation, or a limited liability company which has elected to be taxed as a corporation)
- Have only one class of stock
- Have no more than 100 shareholders
- Spouses are automatically treated as a single shareholder. Families, defined as individuals descended from a common ancestor, plus spouses and former spouses of either the common ancestor or anyone lineally descended from that person, are considered a single shareholder as long as any family member elects such treatment.
- Shareholders must be U.S. citizens or residents and natural persons, so corporate shareholders and partnerships are generally excluded. However, certain trusts, estates, and tax-exempt corporations, notably 501(c)(3) corporations, are permitted to be shareholders.
- Profits and losses must be allocated to shareholders proportionately to each one’s interest in the business.
Limited Liability Companies (LLCs)
An LLC is a hybrid business entity which has characteristics of both a corporation and a partnership, or sole proprietorship in some cases.
Discuss the advantages and disadvantages of limited liability companies
- The primary characteristic an LLC shares with a corporation is limited liability, and the primary characteristic it shares with a partnership is the availability of pass-through income taxation (i.e. no double taxation).
- An LLC is often more flexible than a corporation, and it is well-suited for companies with a single owner.
- There are a number of advantages and disadvantages associated with LLCs, and many of the specific advantages and disadvantages relate to certain states and districts.
- double taxation: Double taxation is the levying of tax by two or more jurisdictions on the same declared income (in the case of income taxes), asset (in the case of capital taxes), or financial transaction (in the case of sales taxes). This double liability is often mitigated by tax treaties between countries.
Limited Liability Companies (LLCs)
A limited liability company (LLC) is a hybrid business entity that has characteristics of both a corporation and a partnership (or sole proprietorship depending on how many owners). An LLC, although a business entity, is a type of unincorporated association and is not a corporation (calling it a limited liability corporation is incorrect). The primary characteristic an LLC shares with a corporation is limited liability, and the primary characteristic it shares with a partnership is the availability of pass-through income taxation (i.e. no double taxation). It is often more flexible than a corporation, and it is well-suited for companies with a single owner.
Membership interests in LLCs and partnership interests are also afforded a significant level of protection through the charging order mechanism. The charging order limits the creditor of a debtor -partner or a debtor-member to the debtor’s share of distributions, without conferring any voting or management rights on the creditor. Limited liability company members may, in certain circumstances, also incur a personal liability in cases where distributions to members render the LLC insolvent.
Some advantages of LLCs include the following:
- choice of tax regime: an LLC can choose to be taxed as a sole proprietor, partnership, S or C corporation;
- much less administrative paperwork and record keeping than a corporation;
- pass-through taxation (i.e., no double taxation), unless the LLC elects to be taxed as a C corporation;
- less risk to be stolen by fire-sale acquisitions (more protection against hungry investors).
Some disadvantages of LLCs are listed below.
State laws regarding stock corporations are very well developed and provide for a variety of governance and protective provisions for the corporation and its shareholders. However, most states do not dictate detailed governance and protective provisions for the members of a limited liability company. Thus, in the absence of such statutory provisions, the members of an LLC must establish governance and protective provisions pursuant to an operating agreement or similar governing document.
It may be more difficult to raise financial capital for an LLC as investors may be more comfortable investing funds in the better-understood corporate form with a view toward an eventual IPO.
Many jurisdictions levy a franchise tax or capital values tax on LLCs. In essence, this franchise or business privilege tax is the fee the LLC pays the state for the benefit of limited liability. The amount of the franchise tax can be based on the following:
- number of owners,
- amount of capital employed in the state.
There can also be some combination of the above factors, or simply a flat fee.
Publicly Held Corporations
Government-owned companies are either partially or fully owned by a government and have both a distinct legal form and commercial presence.
Distinguish between a state-owned enterprise, government-linked company, and quasi-governmental organization
- There are many possible levels of government involvement in publicly-owned companies. Governments can fully or partially own a company as well as own regular stock.
- While they may also have public policy objectives, publicly-owned companies are differentiated from other forms of government agencies or state entities established to pursue purely non-financial objectives.
- Government-linked companies and quasi-governmental organizations also provide ways for government to be involved in corporations, either through a holding company or through government funding.
- state-owned enterprise: A legal entity created by a government to undertake commercial activities on behalf of an owner government.
- government-linked company: A private or public corporate entity in which an existing government owns a stake through a holding company.
- quasi-governmental organization: A corporation, business or agency that is regarded by national laws and regulations as being under the guidance of the government, but also separate from the government.
There is no standard definition of a publicly-owned corporation or state-owned enterprise (SOE), although the two terms can be used interchangeably. Their defining characteristics are their distinct legal form, and their operation in commercial affairs. While they may also have public policy objectives, SOEs are different from other government entities established to pursue purely non-financial objectives.
State-owned enterprises can be fully or partially owned by the government. However, the line beyond which a corporation must be considered “state-owned” is unclear, as governments can also own regular stock and have no special influence over business. For example, in 2007 the Chinese Investment Corporation agreed to acquire a 10% interest in the global investment bank Morgan Stanley, but it is unlikely that this would qualify the latter as a government-owned corporation. SOEs are often the result of corporatization, a process in which government agencies are re-organized as semi-autonomous corporate entities.
The term government-linked company (GLC) is sometimes used to refer to private or public corporate entities in which an existing government owns a stake through a holding company. There are multiple ways of defining GLCs, depending on the proportion of the corporate entity a government owns. One rationale for calling a company a GLC is whether or not a government owns an effective controlling interest (>50%); another possible definition defines as a GLC any corporate entity that has a government as a shareholder.
A quasi-governmental organization is a corporation, business or agency that is regarded by national laws and regulations as being under the guidance of the government, but also separate from the government. While they may receive some revenue from charging customers for services, these organizations are often at least partially funded by the government. Sometimes they are even propped up with cash infusions in times of crisis to help offset situations that would bankrupt a normal privately owned business.
A notable example of an SOE is the Saudi national oil company, Saudi Aramco, which the Saudi government bought in 1988. The Saudi government also owns and operates Saudi Arabian Airlines, as well as many other companies.
Nonprofit Organizations (NPOs)
A nonprofit organization is an organization that uses surplus revenues to achieve goals rather than to distribute them as profit or dividends.
Describe the types of nonprofit organizations, as well as their legal aspects and organizational goals
- While not-for- profit organizations are permitted to generate surplus revenues, they must be retained by the organization for its self-preservation, expansion, or for other plans.
- The two major types of nonprofit organizations are membership and board-only. A membership organization elects the board, has regular meetings, and the power to amend the bylaws. A board-only organization typically has a self-selected board.
- Some NPOs may also be a charity or service organization; they may be organized as a not-for-profit corporation or as a trust, a cooperative, or they exist informally.
- revenues: In business, revenue or turnover is income that a company receives from its normal business activities, usually from the sale of goods and services to customers.
- nonprofit corporation: a company that uses surplus revenues to achieve its goals rather than distributing them as profit or dividends
A nonprofit organization (NPO) is an organization that uses surplus revenues to achieve its goals rather than to distribute them as profit or dividends. While not-for-profit organizations are permitted to generate surplus revenues, they must be retained by the organization for its self-preservation, expansion, or for other plans. NPOs have controlling members or boards. Many have paid staff, including management, while others employ unpaid volunteers and even executives who work with or without compensation (occasionally nominal). Where there is a token fee, in general, it is used to meet legal requirements for establishing a contract between the executive and the organization. The extent to which an NPO can generate surplus revenues may be constrained, or use of surplus revenues may be restricted.
The two major types of nonprofit organizations are membership and board-only. A membership organization elects the board and has regular meetings and power to amend the bylaws. A board-only organization typically has a self-selected board, and a membership whose powers are limited to those delegated to it by the board. A board-only organization’s bylaws may even state that the organization does not have any membership, although the organization’s literature may refer to its donors as members; examples of such organizations are Fairvote and the National Organization for the Reform of Marijuana Laws.
Nature and Goals
Some NPOs may also be a charity or service organization; they may be organized as a not-for-profit corporation or as a trust, a cooperative, or they exist informally. A very similar type of organization termed a supporting organization operates like a foundation, but they are more complicated to administer, hold a more favorable tax status, and are restricted in the public charities they support.
NPOs have a wide diversity of structures and purposes. For legal classification, there are some elements of importance:
- Economic activity,
- Supervision and management provisions,
- Accountability and auditing provisions,
- Provisions for the amendment of the statutes or articles of incorporation,
- Provisions for the dissolution of the entity,
- Tax status of corporate and private donors,
- Tax status of the foundation.
Some of the above must be, in most jurisdictions, expressed in the charter of establishment. Others may be provided by the supervising authority at each particular jurisdiction.
While affiliations will not affect a legal status, they may be taken into consideration by legal proceedings as an indication of purpose.
Most countries have laws which regulate the establishment and management of NPOs and require compliance with corporate governance regimes. Most larger organizations are required to publish their financial reports detailing their income and expenditure publicly. In many aspects, they are similar to corporate business entities though there are often significant differences. Both not-for-profit and for-profit corporate entities must have board members, steering committee members, or trustees who owe the organization a fiduciary duty of loyalty and trust. A notable exception to this involves churches, which are often not required to disclose finances to anyone, including church members.