Entrepreneurs and small business owners tend to organize their operations through entities such as LLCs and corporations for practicality and liability protection reasons. Before LLCs were legally able to be established (before the early 1990s), the only practical entities to organize businesses were corporations and limited partnerships.
Limited partnerships have some value in asset protection but are cumbersome to maintain and confusing to administer, especially compared to LLCs.
Corporations continue to be used to structure some new businesses. Corporations provide no liability protections that are not provided by LLCs. In fact, Ohio LLC law actually includes a few “mandatory” liability protection provisions for LLCs that corporations enjoy only if reserved by the corporation.
There can be some legitimate tax reasons for a new business to be organized as a corporation instead of an LLC. Usually, a primary reason for choosing a corporation over an LLC deals with the tax deductibility of a limited number of business expenses that are not tax deductible for LLCs and partnerships.
Also, for business owners with a high income that puts the owners in very high tax brackets, subsection c corporations can help defer income until the owners may have less income from other sources. The trade-off for this deferral of income is that the income can be taxed a second time when it is actually disbursed from the corporation. Nonetheless, the tax savings in these circumstances can sometimes outweigh the negative tax implications of the potential double-taxation.
However, most corporations are subsection s corporations (which avoids double-taxation) instead of subsection c corporations.
Therefore, generally corporations and LLCs have similar liability and tax attributes. LLCs are easier to set up, easier to manage (no annual meetings or extra detailed corporate record-keeping) and easier to dissolve and shut down than corporations. Thus, most new business entities are LLCs.
Nevertheless, caution should be exercised when establishing and otherwise continuing to use existing corporations.
The biggest practical challenge associated with corporations deals with assets owned by a corporation that gain value over time. When ownership of the more valuable asset is transferred out of the corporation (even to the corporation’s shareholders), at least the increased value of the asset is subject to tax, just as if the asset was sold to an unrelated party for fair market value. For this reason, a great deal of real estate is “stuck” in corporations established decades ago, because the tax implications of removing the real estate from the corporation would be immense.
Sometimes, the only practical way, albeit cumbersome, to move certain assets out of a corporation to a shareholder without any tax implications is to create a new, subsidiary corporation. Then, move the certain assets into the new subsidiary corporation. And, finally, swap out shares between the corporations such that the shareholder who wants the certain assets owns all of the shares of the corporation that only owns the certain assets. This process is complex, includes numerous requirements and typically never moves the certain assets from remaining in the new corporation.
Lee R. Schroeder is an Ohio licensed attorney at Schroeder Law LLC in Putnam County. He limits his practice to business, real estate, estate planning and agriculture issues in northwest Ohio. He can be reached at Lee@LeeSchroeder.com or at 419-659-2058. This article is not intended to serve as legal advice, and specific advice should be sought from the licensed attorney of your choice based upon the specific facts and circumstances that you face.