Ode No Title
| Jurisdiction | Vermont,United States |
| Citation | Vol. 2001 No. 12 |
| Publication year | 2001 |
December 2001. Ode No Title
Paul H. Ode, Jr., Esq.
In recent years, Vermont has revamped its corporations, partnerships, and limited partnerships statutes and added a statute permitting formation of limited liability companies (or "LLCs"). Entities formed under each of these statutes can shield the owners from personal exposure to the business's liabilities. With so many choic-es available, what is the best entity to use? There are significant tax and non-tax dis-tinctions among the options, and the selec-tion must be made in light of a particular company's circumstances. Here are answers to ten questions you might be asked by a client or a colleague.
1. I understand the difference between an S and a regular C corporation. What is a close corporation and how is it different?
Keep in mind the distinction between the classification of a business entity for state law purposes (which deals with issues such as limited liability and require-ments for running the business) and its tax classification. Since 1994, Vermont has permitted formation of close corporations under Chapter 20 of Title 11A.(fn1) A close corporation may have no more than thirty-five shareholders, may operate without a board of directors, may not need to adopt bylaws, and can operate with less formali-ty than a corporation formed under Chapter 2 of Title 11A.
A close corporation's tax status, howev-er, is an independent issue. A close corpo-ration will be treated as a C corporation unless it qualifies for treatment as an S corporation and timely elects the "pass-through" treatment available under Subchapter S of the Internal Revenue Code ("IRC").
2. With the drop in individual income tax rates does it make sense to organize my business as a regular C corporation?
When the top marginal rate for individ-uals was 39.6% and the top marginal rate for corporations was 35%, it was frequent-ly advantageous to organize a business as a C corporation as long as the entity did not hold assets expected to appreciate in value and the business plan called for retaining earnings for capital investment. As a result of the 2001 tax act, the 39.6% bracket is gradually reduced so that it will be 35% by 2006.(fn2)
There are still some attributes of a C corporation that are attractive, such as the availability of tax-advantaged fringe bene-fits for owners of the business and the 50% capital gains exclusion potentially avail-able under IRC 1202. The reduction in individual tax rates, however, makes enti-ties that offer pass-through taxation more attractive than ever.
3. Why do the venture capital providers prefer funding C corporations?
A good question. For start-up business-es generating losses, a flow-through entity such as an LLC generally provides tax benefits that make it preferable to a C cor-poration. A profitable C corporation may distribute after-tax earnings to sharehold-ers in the form of dividends. In computing their tax liability, however, shareholders must generally include C corporation dis-tributions in income, and cannot use C corporation losses as deductions. Since LLCs can have multiple classes of equity interests and it is possible to fashion an LLC membership interest comparable to convertible preferred stock, one might...
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