Why Corporate Structure Matters

An extended reply to a comment posted earlier today, regarding the importance of legal and financial structures in setting up humane organizations:
When LLC’s first became available, most advisors (lawyers and accountants) didn’t recommend them because they were untested in the courts as regards liability and whatnot. At that time, the operating agreements were expensive to draft because there was no boilerplate language to draw from. Now, you can set up an LLC professionally for $500 – $750 (nothing fancy). Or buy the Nolo Press books for $50 and figure it out for yourself. But this is a recent development.
Even now, my personal advisors, some of the brightest independent professionals in this Ivy League town, are not sure what to make of my thoughts for forming a software co-op. “Why not just do an LLC?” they say.
Structure matters because at the end of the year you have to file tax returns. The IRS doesn’t allow creative new approaches, you have to map your state requirements onto the Federal possibilities. So when you set up an LLC there are a few questions that determine how the business is treated for tax purposes. Somewhat counter-intuitively, you can have your LLC treated as Sole Proprietorship, Partnership, C Corporation or S Corporation for tax purposes. This is why the LLC is so popular – it’s a very flexible instrument.
An interesting aspect of the tax treatment of co-ops is that the amount refunded as patronage refund is tax-deductable to the co-op. This avoids the normal double-taxation of dividends. In addition, many co-ops pay a portion of their refunds in member equity (stock) increasing the co-op’s tax-deductable amount and keeping the member from having to pay income tax on that equity gain until such time as the stock is sold, thus resulting in capital gains taxes, typically at a lower tax rate.