Business Entities and Considerations
Entity Classification and the Check-the-Box Rules
A candidate must be able to move fluidly between default classifications and elective ones. An unincorporated single-owner entity is by default a disregarded entity; a multi-owner unincorporated entity is by default a partnership. An eligible entity may elect corporate or partnership treatment on Form 8832, and a single-member LLC may elect corporate status. The trap is assuming a state-law label controls: an LLC with two members is a partnership for federal tax unless it elects otherwise, while a state-law corporation is always taxed as a corporation and cannot check the box.
Formation, Basis, and Distributions
Know the basis rules cold. Contributions to a partnership or corporation generally produce carryover basis and nonrecognition under the contribution provisions; partnership liabilities shift basis under the allocation rules, while corporate assumption of liabilities is generally tax-free unless the debt exceeds basis. Distributions differ sharply: corporate distributions are dividends to the extent of earnings and profits, then return of basis, then gain; partnership distributions are generally nonrecognition events tested against outside basis.
Choice-of-Entity Consequences
Questions frequently test the double-tax versus single-tax tradeoff, self-employment tax exposure, fringe benefit availability, and the ability to make S elections. An S corporation requires an eligible domestic corporation with permissible shareholders and a single class of stock; an ineligible shareholder or a second economic class terminates the election.
Worked Example
A two-member LLC contributes property with a $40,000 basis subject to a $30,000 recourse liability. Under default partnership treatment the contributing member's basis is $40,000 less the $15,000 share of debt assumed by the other member, or $25,000. If the entity had elected corporate status, basis would be $40,000 with no reduction for the liability.