[RoseMarie]

The following scenario is from a REG sim where you have to deiced which business structure would best fit the situation out of S Corp, C Corp, General partnership, Limited partnership, or LLC:

Two individuals are planning to form a business with equal ownership. The individuals would like to limit their personal liability, avoid double taxation, and be active in the business. What type of business entity would meet their requirements?

This is the solution given:
A limited liability company limits members’ personal liability, allows all members to actively participate in the business, and passes all earnings through to the members proportionately, avoiding double taxation. C corporation profits sometimes are subject to double taxation. A limited partnership requires at least one general partner. All general partners bear unlimited personal liability.

I understand why it isn’t C corp, General partnership, or Limited partnership but can someone explain why it isn’t S corp?

[ahugemistake]

I broke down the question to understand it better, and I think I know why an LLC would be preferred over S-Corp.

Two individuals are planning to form a business with
1. equal ownership
2. The individuals would like to limit their personal liability
3. avoid double taxation,
4. and be active in the business.

What type of business entity would meet their requirements?

So 1, 2 and 3 are all possible with both LLC and S-Corp. The active participation is where the twist comes in on #4 with material participation rules.

If a shareholder materially participates in the operations of an S corporation, the passthrough of nonseparately stated (ordinary) income or loss is nonpassive. The income or loss passed through is passive if the shareholder does not materially participate.
Source: https://www.thetaxadviser.com/issues/2011/aug/casestudy-aug2011.html

So the preferred business entity would be a LLC.

FAR - 78*
AUD - 66, 79
REG - 73, 76
BEC - 79

[RoseMarie]

I see, thanks so much for the explanation! I haven't done the flow through sections yet (this was in Business law which was what I started with) so I didn't know criteria for active versus passive participation. That helps a lot!

[ahugemistake]

I used Wiley to study and the structure of the topics is so confusing. I didn't understand anything when I read the formation topics. I just kept pushing through and came back to them. It makes sense on the second time around. Goodluck with your REG studying!

FAR - 78*
AUD - 66, 79
REG - 73, 76
BEC - 79

[Author]

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