Anyone considering starting a brewery needs to consider what type of entity the brewery should be formed as. The two forms which most small businesses take are the S-corporation and the limited liability company (LLC), and are likely the two forms that most brewery owners would be deciding between when first opening their business.
What is a C-corporation?
C-corporations are the most common corporate form, but are usually disfavored by start-ups and small businesses, such as breweries, because C-corporations face double taxation. Double taxation means that the corporation itself will be taxed when any income is earned and the shareholders will be taxed when the profits are distributed by the corporation. Another big drawback of a C-corporation is that the owners and shareholders of a C-corporation do not have the ability to personally deduct any losses sustained by the company, something that can be very beneficial during the early years of a start-up brewery. Finally, if a start-up fails to satisfy any requirement to become an S-corporation, the company will automatically become a C-corporation, which is another reason many start-ups at least attempt to register as an S-corporation.
What is an S-corporation?
S-corporations are corporations which avoid the burden of double taxation that C-corporations face by satisfying several requirements of the Internal Revenue Code and the New York Tax Law. These requirements include: (1) no more than 100 shareholders; (2) only U.S. individuals (with certain exceptions), certain trusts, and tax exempt organizations can be shareholders; (3) the corporation can only have one class of shares; and (4) the corporation must make an S-corporation election with both the IRS and the NY Department of Taxation and Finance.
However, soon-to-be breweries should keep in mind that New York City does not recognize S-corporations and the entity’s net income from doing business in New York City will be subject to the City’s General Corporation Tax.
What is an LLC?
An LLC is a company which provides the limited liability protections of a corporation with the “pass-through” tax incentives of a partnership. This “pass-through” incentive is similar to the avoidance to double taxation by the S-corporation, where only the members, and not the entity, are taxed. The LLC does not have the same shareholder restrictions of an S-corporation, but it does, however, have several filing requirements not required by an S-corporation.
Why choose an S-corporation?
An S-corporation avoids that double taxation problem faced by C-corporations. Also, shares in the S-corporation, including the voting rights, owned by shareholders are freely transferable in accordance with the law and bylaws of the S-corporation. The filing requirements and fees of an S-corporation are relatively small. The corporation must also make a timely election on the IRS Form 2553 and NY Department of Taxation and Finance Form CT-6. Before filing their Certificate of Incorporation, the soon-to-be S-corporation should reserve their name with the Department of State.
Shareholders are not liable for the S-corporation’s obligations. A shareholder’s liability of an S-corporation is limited to the shareholder’s contribution; however the ten shareholders with the most equity ownership will be personally liable, jointly and severally, for any unpaid wages of the S-corporation’s employees. The board of directors, who manage the S-corporation, are protected in New York by the business judgment rule, which gives deference to management decisions if they are honest and made in good-faith. Also, the owner/shareholders of an S-corporation have the ability to deduct the losses of the company directly on their personal income taxes, subject to certain loss disallowance rules.
Why choose an LLC?
LLCs provide similar limited liability protections and tax incentives as an S-corporation, without the shareholder requirements. An LLC can be formed by one or more members, but don’t have the ability to be taxed as a partnership until it has at least two members. Unlike an S-corporation, there are no additional requirements regarding the members of the LLC. Further, an LLC can have multiple classes of membership interests, with different rights provided among the classes. Unlike an S-corporation, there are several filing requirements and fees for the formation of an LLC. First, the soon-to-be LLC must file an Articles of Organization with the Department of State, along with a $200 filing fee. The LLC should also reserve their name before filing their Articles of Organization, which is a $20 fee. The LLC must also publish a notice of their organization in the appropriate newspapers for specific amounts of time. The fee for this publication will depend on the newspaper and can vary greatly across counties. Within 120 days of the filing of the Articles of Organization with the Department of State, the LLC must file documentation regarding the publication with the state.
Like an S-corporation, a member’s liability is generally limited to their contribution to the LLC. The members are not liable for the debts of the LLC or the debts/obligations of any other member, unless the operating agreement provides otherwise. The ten members with the largest equity share in the LLC will be personally liable, jointly and severally, for any unpaid wages of the LLC’s employees. Similar to the directors of an S-corporation, the managers of the LLC are protected by the business judgment rule.
So which entity is best for your soon-to-be brewery? This decision is a fact-intensive one and should be made with the guidance of an attorney who has knowledge of those facts. Further, an experienced attorney would be able to provide guidance and expertise when it comes to any necessary filing or communication with the New York Department of State, the New York Department of Taxation and Finance, and the IRS.
Please see www.trademarkyourbeer.com for more information about brewery trademarks. This blog is intended to provide general information on a wide range of issues, including legal issues, affecting the brewing industry. It is not intended to provide specific legal advice and no legal advice is given. You understand that merely using this blog does not create an attorney client relationship between you and any attorney at Harris Beach PLLC or Brendan Palfreyman. The blog should not be used as a substitute for competent legal advice from a licensed professional attorney in your state. This blog is intended to provide general information on a wide range of issues, including legal issues, affecting the brewing industry. It is not intended to provide specific legal advice and no legal advice is given.