Entity choice and planning strategies

Area 3: Advanced Tax Concepts (10-20%)

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Topics

Entity selection factors
Conversion between entity types
Multi-entity structuring

Lessons

Entity Choice and Planning

Study Frameworks

Entity Type Comparison

Business Entity Selection

C Corporation

Double taxation: corporate rate (21%) + shareholder dividend tax

Unlimited shareholders, no restrictions

Retained earnings accumulation (beware PHC and accumulated earnings tax)

S Corporation

Flow-through: income/loss passes to shareholders

100 shareholders max, 1 class of stock, no NRA shareholders

Reasonable compensation required; excess = distributions (no SE tax)

Partnership / LLC

Flow-through: special allocations allowed (must have substantial economic effect)

No entity-level tax (unless elects otherwise)

General partners: SE tax on distributive share

Flexible: can distribute different items to different partners

Sole Proprietorship

Schedule C: all income subject to SE tax

No liability protection

Simplest formation and compliance

Entity Choice Decision Tree

Does the business need to retain earnings for growth and access public capital markets?

Yes

C corporation — 21% flat rate, unlimited shareholders, public offering capability, but double taxation on distributions

Are there 100 or fewer US-resident shareholders, and is one class of stock acceptable?

Yes

Is avoiding self-employment tax on distributed profits a priority?

Yes

S corporation — flow-through taxation, reasonable salary required, excess distributions avoid SE tax

Do the owners need flexible profit/loss allocations (special allocations)?

Yes

Partnership / LLC (partnership-taxed) — maximum flexibility, special allocations, but GP has SE tax

S corporation — simpler compliance than partnership, SE tax savings on distributions

Are there foreign owners, multiple classes of equity, or more than 100 investors?

Yes

Partnership / LLC or C corporation — S election not available; choose based on double taxation tolerance vs. flexibility needs

Sole proprietorship — simplest option for single owner; all income subject to SE tax

Entity Comparison Table

Feature	C Corporation	S Corporation	Partnership	Sole Proprietorship
Formation	IRC 351 (tax-free if 80% control)	IRC 351 + S election	IRC 721 (tax-free, no control test)	No formal formation
Taxation	Double: 21% corporate + dividend tax	Flow-through to shareholders	Flow-through to partners	Schedule C on Form 1040
SE tax	Not applicable (salary + dividends)	Salary only; distributions exempt	GP: SE tax on distributive share; LP: generally exempt	All net income subject to SE tax
Owners	Unlimited; any type	Max 100; US individuals/certain trusts/estates only	Unlimited; any type	Single owner only
Liability	Limited (corporate veil)	Limited (corporate veil)	GP: unlimited; LP/LLC members: limited	Unlimited personal liability
Special allocations	Not available	Not available (1 class of stock)	Allowed (substantial economic effect)	N/A
Basis includes debt	No	Direct shareholder loans only	Yes — all partnership liabilities	N/A
Liquidation	IRC 331/336 (double tax)	IRC 331/336 (single tax — flow-through)	IRC 731 (generally tax-free)	No separate event

100-1-No NRA100 shareholders, 1 class of stock, No Nonresident Aliens

The three key S corporation eligibility requirements. Also: shareholders must be individuals, certain trusts, or estates (no C corps or partnerships). Must be a domestic corporation.

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