Benefits and Burdens of Subchapter S in a Check-the-Box World

Abstract

The Treasury's issuance of the check-the-box regulations (CTB) in late 1996 has intensified debate about whether there should be a single federal income tax regime for all private business firms (PBFs), including passthrough entities, whose equity interests are not publicly traded. This revived concern for parity in tax treatment among the various forms of passthrough entities arose because the CTB regulations generally allow a business entity with two or more owners to be taxed as a partnership for federal income tax purposes, regardless of its organizational structure and corporate-like characteristics under state law. Before the CTB regulations, unincorporated entities were required to maintain at least two noncorporate characteristics in order to avoid the double tax regime of Subchapter C. Revenue Ruling 88-76, which permitted limited liability companies (LLCs) to achieve partnership tax status under the former regulations, inspired state legislatures to jump on the LLC bandwagon by adopting LLC statutes and amending existing LLC statutes to conform to liberalized federal income and transfer tax interpretations. All states now have limited liability company laws, and many have added the limited liability partnership (LLP), which is a hybrid form of organizational structure, between the LLC and the limited partnership (LP), intended primarily for professional service organizations. The primary benefit of the LLP is that it insulates partner-members in professional service organizations from vicarious liability for malpractice errors and omissions.