entity

Article Sam Stephenson

For companies in the life sciences sector, choosing the right legal structure for your business is a critical step with lasting tax, fundraising, and strategic implications. Whether you’re launching a biotech startup, developing a new medical device, or scaling an established pharmaceutical company, your entity choice can impact everything from how you raise capital to how your company is taxed and what liability protections you receive.

Below, we outline the key entity types commonly used in the life sciences industry, along with their tax advantages, limitations, and strategic considerations.

Single-Member LLC

A single-member LLC is a simple, flexible structure for businesses with one owner. It is typically treated as a disregarded entity for federal tax purposes, meaning the business’s income and expenses flow directly through to the owner’s personal tax return.

Tax Considerations

  • No separate federal income tax return is required (unless the business has employees or excise tax obligations).
  • An Employer Identification Number (EIN) may still be required.
  • SMLLCs may qualify for the federal research credit, which supports companies conducting qualified R&D in fields like biotechnology, engineering, and physical sciences.

Fundraising & Liability

  • Funded through personal assets, loans, or grants.
  • Provides liability protection for the owner.

This structure is often used in the early stages of a company’s development before additional investors or owners come on board.

Partnership

A partnership involves two or more owners who agree to carry on a business for profit. Like a single-member LLC, partnerships are pass-through entities for tax purposes.

Tax Considerations

  • The partnership files an informational return, but the income is taxed at the partner level.
  • Partnerships can allocate income, deductions, and credits to maximize tax efficiency across partners.
  • Partners’ tax basis (i.e., their investment in the partnership) changes with liabilities and contributions, which can affect how distributions or losses are treated.
  • The research credit is passed through to partners in proportion to their ownership.

Fundraising & Liability

  • Can be funded similarly to single-member LLCs with personal assets, loans, or grants, in addition to equity and admission of new partners.
  • General partnerships may expose partners to liability; limited partnerships and LLPs offer more protection.

S Corporation

An S Corporation is a tax election made by a qualifying domestic corporation that allows income and losses to pass through to shareholders for federal tax purposes, but offers some aspects of a C-Corporation structure.

Tax Considerations

  • Avoids corporate-level taxation.
  • Potential savings on self-employment taxes for shareholders.
  • Shareholders must receive a reasonable salary for their work within the S-Corporation.
  • Shareholders are taxed on their share of income relative to their ownership percentage regardless of whether distributions are made.
  • The research credit is passed through to shareholders in proportion to their ownership.

Limitations

  • Only U.S. citizens or residents can be shareholders.
  • Cannot exceed 100 shareholders or issue more than one class of stock.
  • Venture capital and foreign investment are generally not permitted.

Fundraising & Liability

  • Limited in fundraising flexibility due to shareholder restrictions.
  • Offers limited liability protection, important for companies exposed to regulatory or product-related risks.

C Corporation

The C Corporation is the most common structure for high-growth life science companies, particularly those seeking venture capital or preparing for IPOs.

Tax Considerations

  • Pays a flat 21% federal income tax rate.
  • Subject to double taxation: profits are taxed at the corporate level and again when distributed as dividends.
  • Eligible for a range of deductions and credits, including the research credit and the general business credit.
  • Required to make quarterly estimated tax payments if tax liability exceeds $500.

Key Advantage – Section 1202 Stock

C Corps can issue Qualified Small Business Stock under Section 1202, which allows eligible shareholders to exclude up to 100% of capital gains from the sale of stock held for at least five years. This is a significant tax incentive for investors and founders in the life science industry.

Fundraising & Scalability

  • No restrictions on number or type of shareholders.
  • Can issue multiple classes of stock and offer equity-based compensation to employees.
  • Preferred structure for raising venture capital and issuing stock under SEC regulations.

Governance

  • Must maintain a formal structure with a board of directors and corporate officers.

Final Thoughts

For life sciences entrepreneurs, choosing the right entity structure is about more than just legal formalities – it can shape your company’s funding options, risk exposure, tax liability, and long-term growth.

Before making a decision, consult with tax and legal advisors who understand the unique needs of life sciences businesses. The right structure today can lay the foundation for tomorrow’s breakthroughs.

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At the tail-end of this spring’s tax filing season, the Kentucky General Assembly passed House Bill (HB) 5, which included a retroactive pass-through entity (PTE) tax effective for taxable years beginning on or after January 1, 2022. The Governor signed HB 5 on March 31, making it the law effective immediately.

HB 5 was actually the second version of a PTE tax enacted this year. Exactly one week before the Governor signed HB 5, he signed HB 360, which also contained a provision creating a PTE tax. HB 5 substantially overhauled the PTE tax provisions in HB 360 and made several improvements beneficial to taxpayers.

Kentucky now joins a majority of states that have enacted PTE taxes as a workaround for the cap on the federal deduction for state and local taxes. Prior to the enactment of the Tax Cuts and Jobs Act (TCJA), individuals who itemized deductions on their federal income tax return were allowed an unlimited deduction for state and local taxes paid. The TCJA imposed a $10,000 cap on the deduction for tax years beginning after December 31, 2017, and before January 1, 2026. Because of this cap, some individuals are unable to deduct the full amount of state and local taxes they pay.

State PTE taxes allow (or in rare cases, require) owners of PTEs, such as partnerships and S corporations, to pay state tax at the entity-level. Because PTEs are not subject to the $10,000 cap, the entity can deduct the state taxes paid in full, reducing the taxable income passed through to its owners. State PTE tax structures then provide a full or partial credit to the individual owners of PTEs on their state personal income tax returns equal to their share of the tax paid by the pass-through entity.

On June 5, the Kentucky Department of Revenue (DOR) published forms and instructions related to the PTE tax on its website. Form 740-PTET is used to make the election, file the return, and pay the income tax due at the entity-level. Form PTET-CR is used to report the tax paid on each owner’s behalf to each owner of the PTE. Additional guidance on the tax and credit is expected.

The Basics of Kentucky’s PTE Tax

For taxable years beginning on or after January 1, 2022, an “authorized person” may elect annually, on behalf of an “electing entity,” to pay Kentucky income tax at the entity-level. An “authorized person” is any individual with the authority from the electing entity to bind the entity or sign returns on its behalf. An “electing entity” is a PTE that makes an election to pay Kentucky income tax at the entity level. Under existing law, a “pass-through entity” includes any partnership, S corporation, limited liability company, limited liability partnership, limited partnership, or similar entity recognized by the laws of Kentucky that is not taxed for federal purposes at the entity-level, but instead passes to its owners their proportionate share of income, deductions, gains, losses, credits, and similar attributes.

Although the election is optional, once it is made for a taxable year, it is irrevocable and binding on all entity owners. For taxable years beginning on or after January 1, 2023, the election must be made by the fifteenth day of the fourth month after the close of the taxable year or the fifteenth day of the tenth month after the close of the taxable year for returns filed on extension. Thus, for calendar year 2023, the election must be made by April 15, 2024, unless the entity’s tax return is extended.

For taxable years beginning on or after January 1, 2022, but before January 1, 2023, the election may be made after March 31, 2023, but before August 31, 2024. No late payment, late filing, or similar penalty may be imposed on an electing entity that makes the election before August 31, 2024, and no interest applies to the tax paid by the electing entity.

Estimated Tax Payments

For taxable years beginning before January 1, 2024, an electing entity is not required to make estimated income tax payments, and no estimated tax penalty will be assessed. However, for taxable years beginning on or after January 1, 2024, estimated income tax payments are required, and an electing entity may be subject to penalties if the estimated tax payments are not properly made.

Credits for Entity Owners

Owners of electing entities are entitled to a refundable credit against Kentucky’s individual income tax equal to 100% of their proportionate share of the tax paid by the electing entity. The entity must report to each owner the owner’s proportionate share of tax paid for the taxable year. This provision prevents double taxation at the entity and owner level.

In addition, Kentucky residents who are owners of electing entities doing business in another state in which tax is assessed and paid at the entity-level now are allowed a credit for taxes paid to the other state. The credit is based on the owner’s distributive share of the electing entity’s items of income, loss, deduction, and credit.

An Overly Simplistic Example

To understand the operation of the PTE tax credit an example may be helpful. Assume AB Partnership has two owners, A and B, each of whom own fifty percent (50%). Further assume that the partnership has pass-through income of $100,000. Kentucky income tax on the PTE income is $5,000 ($100,000 x 5%). A and B would each receive a PTE tax credit of $2,500 ($5,000 x 50%).

Because Kentucky income tax is not deductible when calculating Kentucky taxable income, A and B’s taxable share of income from the partnership is $50,000. Kentucky income tax at the rate of five percent (5%) will be $2,500 for each partner. However, each partner will receive the PTE tax credit of $2,500, which means $0 Kentucky income tax will be paid on A and B’s distributable share from the partnership by A and B. As a result, Kentucky income tax is paid only once on the income of the partnership, that is, at the entity-level.

The benefit of the PTE tax election is the reduction of A and B’s federal individual income tax. The federal pass-through income for AB Partnership is $95,000 ($100,000 – $5,000 Kentucky tax). A and B’s individual share of that income is $47,500. Assuming a federal tax rate for both partners of 37%, A and B’s federal income tax liability is $17,575 ($47,500 x 37%) each. Without the PTE tax, their tax liability would have been $18,500 ($50,000 x 37%). Thus, the PTE tax saved each partner $925 in federal individual income tax ($18,500 – $17,575). Please bear in mind that this example is overly simplistic, as noted in the next paragraph.

Other Considerations

PTEs and their owners will need to consider several factors when deciding whether to elect to pay tax at the entity-level, including the state of residence of the entity’s owners, whether the PTE does business in other states, whether nonresident owners are able to claim a credit for PTE taxes paid to Kentucky, and other credits available to the PTE or its owners.

If you have questions regarding Kentucky’s PTE tax and whether it could benefit you, contact your Dean Dorton tax advisor or other professional.

For questions regarding this article, please contact Erica Horn.