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Restrictions When Choosing a Business Entity

The type of entity desired might be limited by the individuals or entities that are to be the owners. Some entities have no restrictions on the number and type of owners while other entities have strict limitations that must be complied with to make the selection valid.

C corporations and Limited Liability Companies (LLCs) have no minimum or maximum number of shareholders or owners that may have an equity interest in them. Partnerships require that there be at least two partners and, in the case of a limited partnership, one of the partners must be a general partner and one of the partners must be a limited partner. MCL 449.1101. S corporations must not have more than 100 shareholders. IRC 1361(b)(1)(A)Moreover, S corporations can have only the following kinds of owners:

  1. Individuals. IRC 1361(b)(1)(B). Spouses are counted as one shareholder for purposes of the 100-shareholder rule, and family members who have a common ancestor not more than six generations removed may elect to be treated as one shareholder for purposes of the 100-shareholder rule. IRC 1361(c)(1). Nonresident aliens are not permitted to be shareholders. IRC 1361(b)(1)(C).
  2. Certain retirement plans. IRC 1361(b)(1)(B), (c)(6). Each such plan is counted as one shareholder for purposes of the 100-shareholder rule. IRC 1361(c)(6)(A).
  3. Tax exempt organizations under IRC 501(c)(3). IRC 1361(b)(1)(B), (c)(6). See the discussion regarding unrelated business income tax in §2.79. Each such plan or organization is counted as one shareholder for purposes of the 100-shareholder rule. IRC 1361(b)(1), (c)(6).
  4. Grantor trusts. IRC 1361(c)(2)(A)(i)–(iii).
  5. Voting trusts. IRC 1361(c)(2)(A)(iv).
  6. Qualified subchapter S trusts. IRC 1361(d). Each income beneficiary and potential income beneficiary of such trust is treated as one separate shareholder for purposes of the 100-shareholder rule. Id.
  7. Electing small business trusts (ESBTs). Accumulation and discretionary trusts are permitted to be shareholders if they elect to be an ESBT, as long as all of the following requirements are met:
    1. all of the beneficiaries of the trust must be specifically included in IRC 1361(e)(1)(A) and not specifically excluded under IRC 1361(e)(1)(B);
    2. there cannot be any interests in the ESBT that may be acquired by purchase; and
    3. the ESBT must have filed a written election with the Internal Revenue Service (IRS). IRC 1361(e)(1).
  8. Another subchapter S corporation. Under the Small Business Job Protection Act of 1996 (SBJPA), S corporations may own 100 percent of the shares of a qualified subchapter S subsidiary (QSub).IRC 1361(b)(3). The following requirements must be met to be considered a QSub:
    1. the subsidiary must be a domestic corporation;
    2. the subsidiary must be otherwise eligible to be an S corporation;
    3. the subsidiary must be 100 percent owned by its S corporation parent; and
    4. the parent S corporation must have properly elected to treat such subsidiary as a QSub. IRC 1361(b)(3)(B).
  9. Domestic building and loan associations, mutual savings banks, and certain cooperative banks with shares organized on a nonprofit basis. IRC 1361(b)(2), IRC 1361(c)(6)(A).
  10. Each shareholder must be a U.S. citizen or resident alien. IRC 1361(b)(1)(C).

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