To navigate the herds of the business side of the film industry, you need to have a basic understanding of the different types of legal entities. Almost every transaction involves a selection from a smorgasbord of entities, so it’s important to know the key business, legal and tax distinctions between them.
Sole Proprietorship. A sole proprietorship is a legal entity. he is just a person operating under a fictitious name. These are often referred to as DBAs because the person does business as so-and-so. The good news is that they are cheap and easy to create. The bad news is that because a sole proprietorship is not treated as a separate entity, it does not provide you with liability protection. They are perfect entities to use if you are acting alone (can only be owned by one person) and if you will be responsible for all liabilities anyway.
General partnership. A general partnership is considered to be formed whenever two or more persons join together in a business enterprise to share profits and losses. It requires no filing of any kind, and partnership status cannot be waived by contract (even though almost every contract is supposed to do so). The broad definition of joint venture includes the ubiquitous “joint venture” and “co-production” – the names people often give to a film transaction when they don’t know what else to call it.
In a general partnership, each partner can contractually bind the partnership against third parties, and each partner is personally liable for all partnership debts. For these reasons, it is not common to intentionally form an entity as a general partnership, although it is very common to do so inadvertently by structuring a transaction as a “joint venture” or “joint venture.”
Limited cooperation. Limited partnerships are rarely used in Hollywood, so I’ll skip a discussion of them.
C Corporation. AC Corporation is just a good old fashioned regular company. It is referred to as a C corporation to distinguish it from an S corporation, which is discussed in the next section. “C” and “S” refer to the Subchapter of the Internal Revenue Code governing the respective corporations. None of the shareholders of a C corporation have any liability for the debts of the C corporation.
Generally, a C corporation is the only entity that can go public. However, if you have big dreams of eventually going public, you don’t need to use a C corporation until that magical day arrives. you can and should use something else until then, and you can simply convert it to a C corporation when you go public.
By far, the most significant disadvantage of a C corporation is that it is not transparent for tax purposes, which leads to double taxation. the C corporation is taxed on the income it earns and the shareholders are taxed again when the income is distributed to them. In addition, any losses are tied to the C corporation and cannot be deducted by the shareholders. However, corporations are subject to a very low tax rate (21%, which reduces to 10.5% for foreign income), so they can be attractive if the business operates at a profit and reinvests the profits.
If the C corporation’s income can be saved to the shareholders in the form of deductible compensation, the double taxation loss disappears. The main example is when all of the income earned by the C corporation is attributable to the lending services of its sole shareholder, and these C corporations are referred to as lending corporations. It’s quite common for talent (ie, directors, writers, and actors) to use loan companies to get various tax benefits, such as being able to deduct many expenses that wouldn’t be deductible if the talent was an employee of the film. Company.
It also makes sense for a foreign corporation to use a US C corporation to conduct business in the US, including through a partnership or limited liability company with a third party. This approach will limit the tax exposure (and audits and tax returns) to the US C corporation, as opposed to requiring the foreign corporation to file tax returns, which will expose it to direct scrutiny.
S Corporation. Aside from their unique tax aspects and limitations, S corporations are identical to C corporations in every way. The big difference is that the shareholders must positively elect to become an S Corporation, in which case the corporation is treated as transparent for tax purposes and the income and losses of the S corporation are passed through to its shareholders. Thus, S corporations combine the advantages of both corporations and partnerships. shareholders are not liable for corporate debts, and an S corporation is not subject to double taxation like a C corporation. (However, some states impose a small tax on the net income of S corporations, e.g. California imposes a tax of 1.5 %.)
There are, however, many disadvantages with an S corporation, the most important of which are the following:
• An S corporation cannot have more than 100 shareholders (with members of the same family counted as one shareholder). Therefore, an S corporation cannot be publicly traded.
• With minor exceptions, all shareholders must be persons who are US citizens or residents. This excludes ownership of any type of entity such as a partnership, C corporation, or limited liability company.
• An S corporation can only have common stock. It cannot hold preference shares or any other type of preferred equity ownership. This limitation precludes any type of standard equity financing, as an S corporation cannot provide equity financiers with any type of preference in distributions.
All in all, it’s like playing tennis in a straitjacket, and any misstep can lead to the disastrous consequence of accidentally becoming a double-taxed C corporation. In general, therefore, it’s best to steer clear of S corporations, except for lending corporations.
Limited liability company. Owners of limited liability companies (“LLCs”) are not liable for the entity’s debts, as is the case with a corporation, and LLPs are taxed on a transparent basis, identical to partnerships. They thus combine the advantages of both corporations and partnerships, without the limitations of S corporations. LLCs are by far the preferred type of entity for most film companies other than loan companies.
As mentioned above, an LLC is transparent for tax purposes. If it has two or more members, an LLC is classified as a partnership for tax purposes. If owned by a single member, it is ignored as a separate entity and treated as part of the owner. This gets tricky: for state law purposes, a single-member LLC is treated as a separate entity, providing limited liability to its owner, while for tax purposes it is completely ignored and treated as part of the owner. This is a great result that was not possible before the introduction of LLCs.
A negative consequence of LLCs is that, since they are pass-through entities for tax purposes, individual owners are not subject to the same low tax rate that applies to corporations. Additionally, some states charge a premium for their use. For example, California LLCs are not only required to pay the same minimum annual tax of $800 that corporations and limited partnerships pay, but are also required to pay an additional relatively small tax based on their gross income of about $12,000 in tax to approximately $5 million in gross income.