Business Entity Taxation
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Transcript Business Entity Taxation
Choice of
Business Entity
Jack Cohen, CPA
Asset Protection
IncSmart.biz Inc
Types of Entities
C
CORPORATION
S
CORPORATION
LLC
SOLE
PROPRIETOR
PARTNERSHIP
Identifying the Objectives
Items To consider
What’s at Risk?
Tax Savings
Asset Protection
Management
Capitalization
Exit Strategies
Chances of IRS Audit
F.Y. 06
Form 1040 Sch. ‘C’ > $100,000 = 3.90%
1120 < 10 Mill. Assets = .80%
1120-S = .38%
1065 = .36%
Tax Savings
Income Tax
Payroll Taxes
Self Employment
Gift and Estate Taxes
Asset Protection From:
Business Activities Risk
Management Actions
Employee Actions
Management
Will management be expanded?
How will management disputes be resolved?
How will they be compensated?
Equity participation
Compensation
Additional fringe benefits
Capitalization –
What Form Should it Take?
Initial Capitalization
Debt
Bank loans
Home equity loans
Family and friends
Equity
Corporation- stock
Partnership- partner interest
Limited liability companymember interest
Debt
Pros
Interest tax deductible
No ownership dilution
Flexible rates and terms
Increases return on equity
Establishes credit rating
Cons
Personal guarantees
Monthly periodic payments
Equity
Pros
Minimum cash outflows
Ease of transfer
Large source of capital
Con
Ownership dilution
Tax Tip
On corporations capitalize for the least amount
possible.
Have company “borrow money” from you.
Example
$1,000 Stock
$99,000 Loan
$100,000 Total Capital
Exit Strategies
Company
Stock redemptions
Competitor
Merger
Acquisition
Asset sale
Stock sale
Family members
Gifting
Death transfers
Acquisition
Management
Management buy-out
(MBO)
Management buy-in (MBI)
Proprietorships –
Non Tax Considerations
Simplicity of form
Unlimited personal liability
Continuity of existence and transferability of
ownership
Limited ownership
Proprietorships –
Tax Considerations
Tax Advantages
Tax Disadvantages
Wages paid to
Self-employment tax
children
At-risk rules
Fringe benefit via
spouse employment
No double taxation
All income taxed at
individual level
Lack of fringe
benefits
Hobby loss rule
Proprietorships –
Taxation
Tax rate depends on filing status
No withholding requirements
15.3% self-employment tax
Total net income determines income tax & Social
Security liabilities
File Schedule C with 1040: Business profit & loss
Taxation of LLC
Single Member LLC: Disregarded Entity
Rev
Ruling 99-5; 99-6
SMLLC – Husband or
Husband & Spouse
Reported on Form 1040
Can not have any other unrelated owner
“Check the Box” Rules
Partnership
taxation is default (minimum two
members)
May choose to be taxed as a corporation
S Corp or C Corp
Real Estate Tip
For Maximum Asset Protection Separate SMLLC for
each property.
Put Real Estate in SMLLC.
Partnership –
Formation Issues
Partnership agreement or operating agreement
Buy/Sell agreement
Contributions of Assets
Limited Life
Liability Issues
LLP vs. General Partnership
Partnership –
Tax Considerations
Tax Advantages
Tax Disadvantages
Tax basis from debt
Inability to reduce payroll
Basis adjustment when
partnership interest
acquired
Tax-free contributions and
distributions of property
Ability to make special
elections
No entity level of tax
taxes
Unfavorable tax treatment
of fringe benefits
Lack of flexibility to select
a tax year end
Technical Termination
Partnership Taxation –
Summary
IRS Form 1065
Generates K-1
No “double taxation”
Self-employment tax
Informational tax return: entity does not pay tax
Taxed at partner level
Income is taxable for FICA
S Corporation –
Tax Considerations
Tax Advantages
Tax Disadvantages
No double taxation
Fringe benefits
Pass-through to shareholders
Tax year-end
No excessive compensation
Built-in gains tax
Ability to reduce payroll taxes
Excess passive income
Ability to use cash method
Basis is reduced even if
Tax-free withdrawals of equity
Possible ordinary loss
treatment for stock losses
no tax benefit
‘S’ Corporation
Who Can Be Shareholder?
U.S. citizen
Estates
Single Member LLC
501 (c) (3) Charities
Qualified Pension plans
Qualified Profit Sharing plans
‘S’ Corporation
Who Can not Be shareholder?
Corporations
Partnerships
LLC’s (not SMLLC)
IRA’S & Roth’s
Sep IRA’s & SIMPLE IRA’s
Non-Resident Aliens
S Corporation Taxation –
Summary
Must make election: Form 2553
Files Form 1120-S
Generates K-1
Informational return
Taxed at shareholder level
Income tax only on proportionate share of income:
No FICA
No corporate tax on sale of assets or liquidation
Partnership vs. S Corp–
Treatment
Social Security
General
partners pay FICA on K-1
income
Shareholders
FICA
S Corp K-1 income: no
Social Security
How Much Does Sub ‘S’ Owner Pay?
In 2000 78.9% of ‘S’ - more than 50% owned by
single shareholder.
Compensation To be Reasonable
36,00 taxpayers > $100,000 profits = 0
compensation.
2001 – Owner salaries 41.5% of operating profits.
2000 – ‘S’ corporations paid 5.7 billion less than if
sole proprietors
Partnership vs. S Corp –
Treatment
Distributions
Ownership Interest
Partnership:
S Corp: ownership restricted
disproportionate
distributions allowed
S Corp: no
disproportionate
distributions
No more than 100 shareholders
Individuals, estates, certain
types of trusts
No foreign shareholders
Only one class of stock allowed
Partnership: no restrictions
C Corporations –
Non Tax Considerations
Limited liability
Administrative burden
Management and control
Continuity of existence and transferability of
ownership
C Corporations –
Tax Considerations
Tax Advantages
Tax Disadvantages
Lower tax rates at
Double taxation of corporate
many income levels
Net income not
subject to Social
Security
Takes maximum
advantage of fringe
benefit deductions
earnings
Excessive compensation
Personal service corporate
limitations
Personal holding company
accumulated earnings taxpenalty taxes
Limitations caused by
corporate ownership changes
C Corporation –
Employee Benefits
Salaries
Reasonable
salaries
Garnishment limitations
Medical benefits
Medical
reimbursement plans
Health savings accounts
Retirement benefits
Educational benefits
Other benefits
C Corporations –
Taxation
Separate entity – separate taxpayer
Files IRS Form 1120
Calendar or fiscal year
Dividends not deductible: double tax on profits
Isolates state operations for nexus
Payroll
Sales
Property
Making the Decision
Proprietorship
S
Corporatio
n
C
Corporati
on
$90,000
$90,000
$90,000
W-2 Income
-
$45,000
$45,000
Net Business
Income
$90,000
$45,000
$45,000
Corporate Tax
$-
$-
$6,750
Personal Tax
$10,136
$11,736
$3,564
FICA & Medicare
$12,718
$6,885
$6,885
TOTAL TAXES
$22,854
$18,621
$17,199
Business Income
MFJ, SD, & Expt
THANK YOU
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