Business Structures

References

• SBA Guide
• IRS Rules

Tax designations vs legal structures

Business Structure

| Structure | Description | | ——————— | —————————————— | | Sole Proprietorship | Unincorporated, single owner | | Partnership | Two or more people doing business together | | LLC | Hybrid entity with liability protection | | Corporation (C-Corp) | Separate legal entity, default is C-Corp | | Nonprofit Corporation | Formed for charitable purposes |

Tax designations

LLC vs Inc

| Feature | LLC (Limited Liability Company) | Inc / Corporation (C-Corp or S-Corp) | | ———————– | ————————————————- | —————————————————- | | Legal Identity | Separate legal entity | Separate legal entity | | Owners | Members (can be individuals or entities) | Shareholders | | Management | Flexible (member- or manager-managed) | Board of directors and officers required | | Taxation (Default) | Pass-through (sole prop or partnership) | C-Corp: Double taxation
S-Corp: Pass-through | | Can Elect S-Corp? | ✅ Yes | ✅ Yes (by filing IRS Form 2553) | | Stock Issuance | ❌ No stock — just membership interests | ✅ Can issue multiple or single classes of stock | | Formalities | Minimal (no board or annual meetings required) | High (meetings, minutes, bylaws, annual reports) | | Profit Distribution | Flexible as per operating agreement | Based on share ownership | | Best For | Small businesses, freelancers, partnerships | Startups, VC-backed firms, businesses issuing equity | | Raising Capital | Harder (no shares to sell) | Easier — can sell stock to investors | | Perpetual Existence | Optional — depends on state & operating agreement | Yes — continues regardless of ownership change | | Self-Employment Tax | Members usually pay full self-employment tax | S-Corp avoids SE tax on distributions (partial) | | Name Suffix | Must include “LLC” or similar | Must include “Inc.”, “Corp.”, “Co.” etc. |

Tax Benefits

The most common way to get tax deductions is by using the funds you’ve invested to cover legitimate business expenses.

These expenses can then be deducted on the S-corp’s tax return (Form 1120-S). Some examples of deductible business expenses include:

• Rent or mortgage interest
• Utilities
• Phone expenses
• Insurance
• Depreciation of equipment and home office (if applicable)
• Salaries and wages paid to employees (including yourself)
• Business-related travel, meals, and entertainment

Basis Limitations in S-Corporations

Basis limitations are a key rule for S-corporation shareholders, determining the maximum amount of losses and deductions they can claim on their individual tax returns.

• When an S-corporation experiences losses, these losses “pass through” to the shareholders to be reported on their personal tax returns.

• However, the basis limitation prevents shareholders from deducting losses exceeding their investment (basis) in the S-corporation.

• This limitation prevents shareholders from deducting more than they have invested in the business, protecting the government from excessive tax deductions

How is basis determined?

Your basis in an S-corporation includes your stock basis and your debt basis. Stock basis: This includes your initial capital contributions to the corporation. Debt basis: This includes direct loans you’ve made to the S-corporation. Important note: Loans guaranteed by the shareholder, but not made directly to the corporation, do not increase debt basis.

Law

The basis limitations for S-corporation shareholders are primarily governed by Internal Revenue Code (IRC) Section 1366(d)(1). This section states that a shareholder’s aggregate amount of losses and deductions cannot exceed the sum of:

• The shareholder’s adjusted basis in their S-corporation stock.
• The shareholder’s adjusted basis in any indebtedness of the S-corporation to the shareholder.

What happens to losses exceeding basis?

Losses that cannot be deducted in the current year due to basis limitations are suspended. These suspended losses are carried over to future years and can be deducted when the shareholder’s basis increases.

If a shareholder disposes of their stock while suspended losses exist, those losses are permanently lost.

Other Loss Limitations:

It’s important to remember that the basis limitation is just one of several loss limitations that apply to S-corporation shareholders. Other limitations include:

• At-Risk Limitations (IRC Section 465): These limits prevent deductions exceeding the amount a taxpayer is personally “at risk” of losing.

• Passive Activity Loss (PAL) Limitations (IRC Section 469): These rules limit the deduction of losses from passive activities (like rental properties) against non-passive income.

• Excess Business Loss Limitation (IRC Section 461(l)): This limitation applies to non-corporate taxpayers and restricts the amount of current-year business losses that can be deducted.

• These limitations are applied in a specific order: basis limitations first, followed by at-risk limits, then passive activity loss rules, and finally the excess business loss limitation

Trader Tax Status (TTS)

• 75% of days (252), trading continuously, 4 trades a day, 750 trades a year
• holding period of less than 30 days
• Not subject to self-employment taxes (15.3%)
• Expenses goes in Schedule C
• Income goes in Schedule D
• MTM - Mark to Market election Section 75(f)