Statistical data on choice of entity is important for two reasons. It gives a business advisor a point of reference based on what others are choosing in determining how a particular business will be taxed and, more generally, how it will fit into the business community. Second, it is what the IRS uses to help allocate its guidance, audit, and other resources.
The IRS is generally about two years behind in gathering and making public detailed statistical information for any tax year based upon the returns filed for that year. So, for example, the latest detailed data released in 2006 covers primarily the 2003 tax year, for which returns were filed in 2004. One exception is the information on sole proprietorships, for which detailed 2004 statistics recently have been released.
The IRS also issues a limited amount of “preliminary” statistical data on later tax years. Because the IRS itself needs this data to forecast and allocate its own resources, it is not surprising to find this data buried in “projection reports.”
The latest of these reports is titled “Fiscal Year Return Projections for the United States: 2006–2013.” That report gives return estimates based on category of business tax return for tax year 2005 as well as projections through 2013.
2006–2013 IRS Projections
The IRS projects that the next several years should add significant increases to the numbers of tax returns filed by partnerships, S corporations, and unincorporated businesses owned by individual taxpayers.
In the Fiscal Year Return Projections report, the IRS forecasts a number of tax return statistics to provide a basis for IRS workload estimates and resource requirements. A glance at the partnership, corporation (including S corpora-tion) and individual business categories show what choice-of-entity decisions the IRS forecasts that taxpayers will make over the next seven years.
For partnership returns:
Total partnerships. A 37 percent increase from 2,863,200 in 2006 to 3,909,000 in 2013.
Partnerships; small business/self-employed. A 36 percent increase from 2,772,100 in 2006 to 3,782,400 in 2013.
Partnerships; large and mid-sized business. A 39 percent increase from 90,700 in 2006 to 126,100 in 2013.
Partnerships; tax-exempt/government entities. A 67 percent increase from 300 in 2006 to 500 in 2013.
For corporate filings, including S corporations:
Corporation income tax total. An 18 percent increase from 6,225,100 in 2006 to 7,349,300 in 2013.
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Corporations; small business/self-employed. An 18 percent increase from 2,772,100 in 2006 to 3,782,400 in 2013.
Corporations; large and mid-sized business. A 13 percent increase from 82,200 in 2006 to 93,000 in 2013.
Corporations; tax-exempt/government entities. A 5 percent increase from 8,400 in 2006 to 7,900 in 2013.
S corporation (Form 1120S). A 34 percent increase from 3,875,000 in 2006 to 5,194,400 in 2013.
For tax returns of individuals reporting business activity on personal tax forms:
Individual; small business/self-employed. A 28 percent increase from 40,993,900 in 2006 to 52,516,200 in 2013.
According to the IRS report, the S corporation is forecast to remain king of the hill and the tax entity of choice for small businesses. Projections indicate that 5.2 million S corporations will operate by 2013 (most of which will be small businesses). In comparison, partnerships for small business/self-employed come in a distant second, with around 3.8 million partnerships projected.
Sole Proprietorships
According to an IRS Statistics of Income Division report, for Tax Year 2004 (the most recent year that comprehensive historical data has been made publicly available) approximately 20.6 million individual income tax returns reported nonfarm related sole proprietorship business activity. Of the $1.13 trillion total for sole proprietorship business receipts in 2004, the IRS, using receipts as a measure of business size, reported the following on category leaders: construction, 17.4 percent ($198.4 billion); retail trade, 16.4 percent ($187.1 billion); and professional, scientific, and technical services, 12 percent ($137.7 billion).
The professional, scientific, and technical services sector had the largest percentage of sole proprietorship profits (23 percent). The sector’s total profit was $56.9 billion. The sector with the second largest profits was healthcare and social assistance ($42 billion).
S Corporations
According to an IRS Statistics of Income Division report, for 2003 (the most recent year that comprehensive historical data has been made publicly available) the S corporation was the most popular corporate entity choice.
The report details that approximately 3.3 million S corporation returns were filed. The IRS reports that, since 1986, S corporation filings have increased at an annual rate of 8.8 percent.
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In 2003, approximately 343,000 corporations elected S corporation status for the first time, the IRS reported. Of the total electing S corporation status for the first time, approximately 253,000 businesses were newly incorporated;
the remaining 90,000 businesses had converted from taxable corporation status to S corporation status.
The four industrial sectors that accounted for the majority of total reported S corporation net income were wholesale and retail trade (41.5 percent);
construction (14.7 percent); manufacturing (12.1 percent); and professional, scientific, and technical services (6.7 percent).
Partnership
According to an IRS Statistics of Income Division report for 2003 (the most recent year that comprehensive historical data has been made publicly available) approximately 2.3 million partnerships filed returns.
Total receipts from operations and investments were $3.2 trillion. The manufacturing sector reported the largest total receipts of any sector ($524.1 billion), followed by the finance and insurance sector ($494.6 billion).
Partners in the finance and insurance sector received 39.9 percent of the total income available for allocation reported for all partnerships, the largest share received by any sector. The real estate and rental and leasing industry sec-tor; and the professional, scientific, and technical services sector, respectively, received 23.2 percent and 14.1 percent of the total income available for alloca-tion reported by all partnerships in 2003.
Historically, partnerships classified in the real estate and rental and leasing sector dominate the statistics for both the number of partnerships and partners, the IRS reported. For 2003, the sector included 45.5 percent of all partner-ships and 41.7 percent of all partners. Additionally, partnerpartner-ships in this sector accounted for 17.1 percent of total partnership net income, and 24.7 percent of total assets for all partnerships.
LLCs as Partnerships
LLCs represent the largest partnership entity type, a meteoric rise considering they did not exist until a few years ago. In 2003, there were slightly more than 1 million limited liability companies, making LLCs, for the second consecu-tive year, the most prevalent partnership entity type. Even though LLCs were the most prevalent type of partnership, limited partnerships still reported the largest share of overall partnership profits. Regarding total LLC category assets, the finance and insurance sector had the largest share (42 percent), followed by the real estate and rental and leasing sector (29.5 percent).
The real estate and rental leasing sector accounted for the largest share of general partnerships (40.3 percent); limited partnerships (57.4 percent); and limited liability companies (44.7 percent).
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S Corporations versus Partnerships
A Treasury Inspector General for Tax Administration (TIGTA) report concludes that S corporations and partnerships are the fastest growing segments of taxpayers filing federal returns.
Between January 2000 and December 2004, the number of S corpora-tions and partnership returns processed annually by the IRS increased from 4.96 million to 6 million (a 21 percent increase), the report stated. The IRS, meanwhile, is projecting that by 2012, the annual number of processed S corporation and partnership returns will increase to 8.49 million (a 42 percent increase from 2004).
The study found that the increase in the number of S corporation returns processed from 2000 through 2004 continued a trend that began in 1997; the year that S corporations became the most common type of corporate entity that filed tax returns. The 3.5 million S corporation returns processed in 2004 represents a 21 percent increase from the 2.89 million S corporation returns processed in 2000.
The study concluded that 1990s-era favorable legal and regulatory changes contributed to make partnerships the fasting growing segments of all filers.
Specifically, the changes involved state government creation of limited liability companies (LLCs) and limited liability partnerships (LLPs); and the federal government’s issuance of a simplified method of entity choice: the check-the-box regulations.
STUDY QUESTIONS
14. According to the IRS Fiscal Year Return Projections report, which type of business will be most common (judging by the number of tax returns filed for that entity type) by 2013?
a. Individual small business/self-employed b. S corporation
c. Partnership d. None of the above
15. Which type of partnership reported the largest share of overall partner-ship profits in 2003?
a. LLCs
b. Limited partnerships c. General partnerships d. LLLPs
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CONCLUSION
This chapter introduced the myriad factors to consider when an organiza-tion makes an entity choice. Those factors include distinguishing different entity types, understanding the federal tax law applicable to each entity type, being aware of the strengths and weaknesses of each entity type, and being knowledgeable of recent tax law changes affecting entity choices. It is hoped that the chapter’s discussion of those factors will provide a sound base of knowledge related to business entity choice.
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2.1
MODULE 1 — CHAPTER 2