Impacts of your entity choice: How transaction structuring changes with a partnership versus an S corporation. 68th Annual William and Mary Tax Conference

• Published in: William and Mary tax conference no. 68; pp. 1 - 39
• Main Authors: O'Connor, Brian J, Schneider, Steven R
• Format: Journal Article
• Language: English
• Published: Williamsburg College of William and Mary, Marshall-Wythe School of Law 01.01.2022
• Subjects: Asset acquisitions; Built-in gains & losses; C corporations; Capital gains; Closely held corporations; Compensation; Corporate profits; Disregarded entities; Elections; Estate planning; Expenditures; Income taxes; Investments; Private equity; REITs; Sales; Stockholders; Tax basis; Tax rates

Partnerships Comparison of S corporations and Partnerships Similarities * Both have one-level of tax * Both have tax character flow through Key Differences * S corporations apply subchapter C limitations that don't exist in aartnerships (80% control, no outside Dasis for entity-level debt, immediate tax on negative tax capital, taxable inkind distributions) * S corporations have strict on-class of equity and shareholder type requirements (partnerships are flexible) * Partnerships have complex aggregateentity and anti-abuse rules When are each used? S corporations * Management companies * When profits exist above "reasonable salaries" that can save on the 3.8% SECA tax (if not otherwise subject to the mirrored Section 1411 NII tax). * Historical entities that elected S corporation status prior to the popularity of LLCs * Converted C corporations Partnerships (LLCs) * Default entity of choice for most general non-public companies * Real estate * Start-up companies not seeking Section 1202 treatment and not forced to be C corporations because of tax-sensitive investors Formation/New Capital Considerations & Operations Formation limitations common to both * Investment Company limitations under Section 351(e) and 721(b) * Taxable in-kind contributions if contribute non-diversified appreciated assets into a corporation or partnership that is treated as an "investment company" * Investment company: a corporation or partnership more than 80 percent of the value of whose assets are held for investment and are readily marketable stocks or securities, or interests in regulated investment companies or real estate investment trusts. * Negative tax capital. Always a capital gain asset even if ordinary income assets inside S corporation * For a stock sale, state taxation determined at shareholder level (e.g., shareholder lives in Florida but business assets in NYC) Partnerships (LLCs) * Can get "credit" for delivering full tax basis step up to buyer * Buyer less concerned about tax history * More flexible for tax efficient partial rollovers (e.g., if the cash and rollover percentages are different between the individual sellers) Primary Acquisition Structures for S corp target * Buy Stock * If no special elections, buyer does not receive inside tax basis step up * Elections under Section 338 can treat stock acquisition as deemed asset purchase, but then seller recognizes asset sale taxes and non-S qualified Buyer owns a C corporation going forward * Buy Assets * Buyer and seller agree on purchase price allocation 1 . 3 .Target Inc. files state-law election to be converted from state law corporation to Target LLC, an LLC. Because Target Inc. was a disregarded entity for federal income tax purposes, this conversion is a non-event for federal income tax purposes. 1. Rev. Proc. 93-27 * No immediate tax on profits-only interest * Profits-only means no immediate liquidation value * Exceptions * No publicly traded partnerships * No dispositions within two years * No certain/predictable income streams * Plus exceptions in Rev. Proc. 2001-43 and 2015 proposed fee waiver regulations Profits Interest Structures Estate Planning Estate Planning Differences S corporations * If S corporation is held by decedent and others, cannot distribute decedent's share of assets out without portion of asset appreciation recognized by other shareholders * Consider life insurance to provide liquidity to redeem out decedent * Timing considerations of inside S corporation gain and offsetting loss on redemption of decedent stock Partnerships (LLCs) * Easier to redeem decedent in-kind without impact to other partners. * Make Section 754 election for estate to step up basis inside partnership (eliminates inside ordinary gains in contrast to S corporation) * Potential to distribute tenancy in common interest to allow non-decedent to defer tax on any real estate asset sales Overall Considerations * Convert to voting and non-voting equity (works for both S corporations and partnerships) * Sale to "defective" grantor trusts (works for both S corporations and partnerships) * Partnerships beware of negative tax capital accounts * Gift recast as taxable sale to the extent of negative tax capital (debt allocation in excess of partner basis) * Consider grouping partnership interests in holding partnership with other higher basis assets to minimize or eliminate negative tax capital * S corporation vs. partnership rules if sale to subchapter J trust at a discount to the inside basis of the assets Discounting - Minority Interest and Lack of