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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