There are many considerations that go into the choice of a particular entity. Many people often ask about a limited liability company or "LLC". This discussion is extremely limited and should not be relied upon without further consultation. There are various implications not discussed herein that may be applicable to your decisions and may have significant tax and legal implications if not reviewed with a tax and legal consultant.

In general, one issue for many clients we find is to assure classification as a partnership (rather than as a corporation) for tax purposes. They find this important because of the fact that a corporation is generally subject to double tax. Thus many clients are steered by accountants and other professionals towards a liability company.

Effective January 1, 1997, the California Franchise Tax Board ("FTB") issued regulations that substantially conformed to the Federal "check the box" rules. These check the box rules had a tremendous impact on the use of LLCs. Essentially, this resulted from organizers not having to worry if the entity had the appropriate characteristics to be classified as a tax partnership. The changes have dramatically reduced uncertainty and the need to obtain tax advice about the appropriate classification of an entity.

LLCs, general partnerships, and limited partnerships are all subject to a single level of federal income tax at the owner level. In California, an LLC is subject to an $800 minimum tax. An LLC registered with the California Secretary of State also is subject to a graduated gross receipts fee. The fee is based on gross receipts from all sources, including income from within and without California.

A corporation which has elected Subchapter S status also is subject to a single tax at the ownership level. While a C corporation is subject to double tax. That is, the tax is applied when the corporation earns the income and then again when the after tax earnings are distributed to the shareholders. The potential double tax results in many C corporations trying to minimize corporate income with deductible salaries. Of course, excessive salaries may be challenged by the IRS and thus many favor an LLC to avoid this risk.

There are no limits on the number or types of owners of an LLC, general partnership, limited partnership, or a C corporation. While an S corporation is limited to having no more than 100 shareholders. In addition, only individuals and certain trusts can be shareholders of an S corporation. Thus, a corporation, nonresident alien, limited liability company, or partnership cannot be a shareholder of an S corporation.

An LLC can have different membership classes with various rights. An LLC can be structured to disproportionately allocate tax benefits or even losses among the investors. An S corporation, on the other hand, can only have one class of stock and all items must be allocated pro rata in proportion to ownership.

Because each set of facts for any particular situation is different, it is essential to seek the advice of counsel before making a decision on the choice of an entity. One can make general observations but they are always attached with a risk that the choice may have disadvantages not contemplated by the lay mind. In general, LLCs are a desirable entity because of their flexibility and avoidance of double tax. However, the gross receipts tax may tilt someone in another direction. In addition, if you're thinking of attracting talent with stock options, you must use a corporation. Venture capital or hedge funds have historically used limited partnership and corporations, not LLCs as the desirable vehicle of choice.

Peter A. Kleinbrodt