Choosing a Business Form 257last business eliminates the need for limited partner investors. Almost as easily,
Phil can eliminate the sole proprietorship since it would seem highly undesir-
able to assume personal liability for whatever damage may be done by a prod-
uct manufactured and distributed to thousands of potential plaintiffs. The
corporation, therefore, appears to be Phil’s obvious choice. It gives the benefit
of limited liability, as well as the transferability and continuity essential to a
business that seems likely to be an acquisition candidate in the future. Again,
the lack of size is not a factor in this choice. Phil will likely act as sole director,
president, treasurer, and secretary.
There remains, however, the choice between subchapters C and S. As
may well be obvious by now, Phil’s corporation fits the most common profile of
the subchapter S candidate. For the first year or more, the corporation will suf-
fer serious losses as Phil pays programmers and marketers to develop and pre-
sell his product. Subchapter S allows Phil to show these losses on his personal
tax return, where they will shelter his considerable investment income. The
passive loss limitations will not affect Phil’s use of these losses, since he is
clearly a material participant in his venture.
Phil could achieve much the same results by choosing an LLC, rather
than a subchapter S corporation. Unfortunately, however, many states require
that an LLC have two or more members, making Phil’s business ineligible. In
states which allow single-member LLCs, there would be little to recommend
one choice over the other. Phil might feel more comfortable with an S corpo-
ration, however, if he fears that suppliers, customers, and potential employees
might be put off by the relative novelty of the LLC. This might especially be
true if he has any plans to eventually go public, as the LLC has not gained wide
acceptance in the public markets. An S corporation can then usually revoke its
S election without undue negative tax effect. Beginning as an S corporation
would also eliminate the need to reincorporate as a corporation prior to selling
the business in a potentially tax-free transaction.
Hotel Venture
The hotel venture contemplated by Bruce, Erika, and Michael presents the op-
portunity for some creative planning. One problem they may encounter in mak-
ing their decision is the inherent conf lict presented by Michael’s insistence
upon recognition and reasonable return for his contribution of the land. Also,
Bruce and Erika fear being unduly diluted by Michael’s share, in the face of
their more than equal contribution to the ongoing work.
One might break this logjam by looking to one of the ways of separating
cash f low from equity. Michael need not contribute the real estate to the busi-
ness entity at all. Instead, the business could lease the land from Michael on a
long-term (99-year) basis. This would give Michael his return in the form of
rent without distorting the equity split among the three entrepreneurs. From a
tax point of view, this plan also changes a nondepreciable asset (land) into de-
ductible rent payments for the business. As their next move, the three may