A Sub-Chapter S in New York

If you are planning to establish a legal business entity (ex: Limited Liability Company (LLC) or Corporation) or have an existing legal business entity in New York and are considering a sub-chapter S election, there are a few things you’ll want to keep in mind.

First, it’s important to understand that single-member LLCs (defaultly treated as a disregarded entity and taxed like a sole proprietorship for tax purposes), multi-member LLCs (defaultly treated as a Partnership) and Corporations making a sub-chapter S election are all considered pass-through entities for federal tax purposes. This means that the entities themselves are generally not subject to income taxes. Profit/loss from the business is passed through to the individual members (LLCs) or shareholders (S-Corps), generally reported on a Schedule K-1 for Partnerships & S Corps, and each member or shareholder reports and pays their respective share of income taxes on their respective share of profit/loss on their individual tax returns.

Eligible single-member LLCs, multi-member LLCs (Partnerships) and corporations (C-Corps) can elect to be treated as sub-chapter S for federal tax purposes in lieu of their default classification. There are various pros and cons associated with making a S election, so it is best to consult with your Accountant, CPA Firm and/or legal counsel so that you may make a well-informed decision.

At the federal level, to make a sub-chapter S election, eligible LLCs will need to file both Form 8832 – Entity Classification Election and Form 2553 – Election By A Small Business Corporation. Eligible corporations (C-Corps) will need to file Form 2553 – Election By A Small Business Corporation. When filing Form 8832, keep in mind that the election may take effect no more than 75 days prior to the date the election is filed or no later than 12 months after the election is filed. When filing Form 2553, keep in mind that the form must be filed no more than 2 months and 15 days after the beginning of the tax year for which the election shall take effect or any time during the tax year preceding the tax year for which the election shall take effect. Both forms do allow “Relief for Late Elections.” Eligibility information is available in the instructions for each form. Your Accountant or CPA Firm should be able to help prepare the necessary forms for you to sign and send to the IRS. The IRS should provide written notice as to the acceptance or rejection of the filing(s) within 60 days of receipt.

At the state level, things start to get complicated. While many states recognize the federal S election at the state level, New York State does not. By default, New York State will treat your entity as a C Corporation for tax purposes even if you have made a federal S election. In order for your entity to be recognized and taxed as a S Corporation at the state level, you must file New York State’s Form CT-6 – Election by a Federal S Corporation to be Treated As a New York S Corporation. Again, your Accountant or CPA Firm should be able to help prepare the necessary form for you to sign and send to the New York State Department of Taxation & Finance (NYS DTF). The NYS DTF should provide written notice as to the acceptance or rejection of the filing within 60 days of receipt. While filing Form CT-6 will allow your entity to be treated as a New York S Corporation for tax purposes, New York State requires most general business corporations to pay a franchise tax at the entity level under Article 9-A of New York law.

One last complication is at the city level. New York City does not recognize the federal S or New York State S elections. Therefore, S Corporations are subject to New York City’s General Corporation Tax (GCT) and will be required to pay this tax at the entity level.

If you are planning to make a S election for your business, be sure to seek and consult with professional counsel (ex: Accountant, CPA Firm) to understand the pros and cons as well as the administrative requirements and tax implications at the federal, state and local levels. As you can see in the case of New York, there are a couple of added complexities at the state and local level that you’ll want to be aware of. A good Accountant or CPA Firm should stay ahead of the game and keep you well-informed but don’t hesitate to ask your Accountant or CPA Firm directly about how the S election works within your state and local levels.

Considerations When Starting A Business: Seeking Professional Counsel

As you get started with your new business, there may come a time when you will need to seek professional counsel from a good business law firm and/or CPA firm. Even if your circumstances may not warrant professional counsel at the onset of your new business, you may eventually need to seek counsel as your business grows. Speaking with a good business law firm and/or CPA firm can help you stay on the straight and narrow and in compliance of the constantly changing local, state and federal regulations, requirements and laws.

Legal Counsel

A good business law firm can provide an array of vital services to your business. They can provide key legal counsel during the initial setup and establishment of your new business, helping you to better understand what the legal implications of your new business venture will be. They can offer important insight to help you operate your business legally and avoid unnecessary risks. They can also serve as a critical line of defense between you, your business and potential third-party litigation.

Business law firms can help you figure out the best legal entity for your business (ex: LLC, Corporation - C-Corp or sub-chapter S), assist with filing the necessary paperwork with the appropriate federal, state and local agencies (ex: Department of State, IRS) to setup the legal entity, prepare Operating or Shareholder agreements specifically customized for your business and act as a designated agent for legal notices. They can help prepare and review contracts/agreements (ex: client contracts, NDAs, merger agreements, employment contracts) and they can step in to provide legal aid/counsel in the event of legal action for or against your business.

CPA Firms

A good CPA firm can provide your business with an array of vital Accounting services. They can provide guidance on the different types of legal entities best suited for your business (ex: LLC, Corporation - C-Corp or sub-chapter S). They can provide insight on the potential tax liabilities and obligations you, as a business owner, should be aware of and can expect. CPA firms can handle a variety of required tax reporting and filings for federal, state and local jurisdictions. They should stay current on all the latest changes to the tax laws and requirements to keep you (and the rest of their clients) compliant and up-to-date on the potential impacts those changes will have on you and your business.

For instance, if your business is a single-member LLC treated as a disregarded entity for tax purposes or a multi-member LLC taxed as a Partnership, the owners or LLC members typically do not take a salary through payroll. An owner of a single-member LLC will take a draw and members of a multi-member LLC taxed as a Partnership will receive what are called Guaranteed Payments in lieu of salary via payroll. In either case, unlike salaries via payroll, payroll taxes are not withheld on the income. As such, owners/LLC members are responsible for making quarterly tax payments to the appropriate federal, state and local tax agencies on the applicable earnings. Failure to make the appropriate payments may result in a huge tax bill and tax penalty at tax time.

In addition, single-member LLCs, multi-member LLCs taxed as Partnerships and corporations taxed as a sub-chapter S (including LLCs that elect to be taxed as a sub-chapter S) are treated as pass through entities for tax purposes whereby the business entities themselves are not taxed. Taxes on income/profit are passed down to the individual owners (usually reported on a Schedule K-1) and reported on their individual tax returns. While LLCs taxed as Partnerships and corporations taxed as a sub-chapter S (including LLCs that elect to be taxed as a sub-chapter S) are not taxed at the entity level, they are still required to file the proper annual Partnership or Corporation tax returns for the applicable tax year.

This is just a scratch on the surface, but you can see how complex the tax obligations and implications can be if you don’t understand how the tax laws affect you and your business and/or have appropriate guidance from a tax professional like a good CPA firm. You and your business can easily fall into a tax maze. A good CPA firm should be an active partner in helping you and your business remain compliant with all applicable tax laws and requirements.

There will be times where it may be necessary for your business law firm and CPA firm to collaborate and work together. For instance, when deciding what type of business entity to form for your business (ex: LLC, Corporation - C-Corp or sub-chapter S), it’s a good idea to get insight from both a legal and an Accounting perspective as different types of business entities will have different requirements and implications. While your law firm and CPA firm won’t necessarily tell you which type of entity to form, they should advise you, make recommendations and offer pros and cons. You’ll want to gain as much insight from their counsel to make a well-informed decision.

It should go without saying that both business law firms and CPA firms can be quite expensive so it’s important to know how and when to properly use these professional resources to avoid unnecessary costs. Far too often, business owners use professional counsel prematurely, fail to use counsel until situations get out of hand, don’t know the right questions to ask and/or how to lead, manage and streamline the conversations. Before you speak with a business law firm or CPA firm, take some time to gather your thoughts and put together an overview of what you want to discuss and the questions you want to ask. Try to keep the conversations on point and focused. Don’t be afraid to ask questions if you are unsure about something being discussed. At the end of any conversation with a business law firm or CPA firm, you should feel comfortable that you have gotten the answers that you needed to get from the conversation.

Considerations When Starting A Business: Putting Together A Game Plan

Now that you’re ready and committed to starting a business, you need to put together a game plan. There are a lot of moving parts when it comes to starting a business so it’s important to be organized, detail-oriented and have all your ducks lined up. You’ll first want to take a “view from 10,000 feet” and then drill-down into the specific details.

During the process, gather information and be prepared to answer a series of questions related to your business venture. This information will be extremely helpful during the setup of the legal entity and establishing business operating parameters as you begin operations. In addition, if you need to consult with professionals (ex: business law firm, CPA firm), this information will help to streamline the conversation. You’ll learn quickly that streamlining conversations and meetings are crucial when dealing with law firms and CPA firms, especially if you don’t want to rack up enormous legal and accounting bills.

Below is a list of questions that you should seek answers to. This list is not intended to be a complete list of questions but serves as a starting point in putting together your game plan.

  • What type of business do you plan on starting?

  • Will you be the sole owner or will there be other owners?

  • Do you or any of the other owners have non-compete agreements (or similar) that would prevent or prohibit you and/or the other owners from joining or participating in this business venture? Are there any potential conflicts of interest?

  • Are you or any of the other owners currently participating in or are a part of another business venture, whether in the same industry or a different industry?

  • Will the business be owned by individuals, another business entity or a combination of individuals and business entities?

  • What will be the name of your business?

  • Is the business name unregistered and available to register with your state’s Department of State?

  • Are there any other individuals, companies or organizations using this business name or names similar that may cause confusion for clients/customers and/or pose legal issues (ex: trademark)?

  • Is the corresponding Internet domain name available for your business name?

  • Are the corresponding social media handles available for your business name?

  • What type of legal business entity is best for your business (ex: LLC – single-member LLC, multi-member LLC taxed as a Partnership, LLC taxed as a sub-chapter S, Corporation – C-Corp or sub-chapter S)?

  • What will be the designated role (ex: job function or area of responsibility) of each owner?

  • What does each owner bring to the table of the business venture?

  • How will the business be managed (by the owners, by designated managers, by owners and designated managers)?

  • How much starting capital do you and your partners have to invest in the business?

  • How much capital will you and your partners need to invest in the business to cover startup costs and at least the first three to six months of business operating expenses?

  • If you and your partners don’t have the necessary capital, how will you and your partners secure the necessary capital (ex: bank loans)?

  • Do you and your partners have a solid credit history and a good/excellent credit rating? Do you and your partners have collateral, if necessary?

  • When do you expect to officially begin business operations?

  • Will the business operate in a single state or multiple states?

  • Where will the principal office for the business be located? Will there be a single office location or multiple office locations?

  • Will you require commercial space for your business?

  • Will you be hiring employees?

  • Will you be using independent contractors or external personnel?

  • What resources will you require to operate your business (ex: supplies, equipment, software)?

  • Do you currently have or are you working with existing clients?

  • Who are your target clients or customers?

  • What’s your business plan or strategy for acquiring new clients or customers?

  • If your business requires inventory, how do you plan on acquiring, storing and securing inventory?

  • Will your business be required to collect sales tax?

  • Does your business operate within an industry that has industry-specific or governmental requirements (ex: certifications, memberships, licenses, permits, insurance)?