From: RhondaWorks
If you're starting a business, one of the first questions you need to answer is what kind of legal form your business will take. The form you choose will affect the taxes you pay, who can invest in your company, and your financial security.
If you're starting a business, one of the first questions you need to answer is what kind of business you're going to be. By this, I don't just mean what kind of products you'll sell or service you'll provide, but what legal form your business is going to take.
Now, this may sound like a question that shouldn't be very important to a very small business. After all, if you're going to be a consultant or a graphic designer or an electrical contractor, why bother dealing with the government? Who needs to pay a few hundred dollars in corporation or legal fees?
But choosing a legal form affects how much you pay in taxes, who can invest in your company, and most importantly, your personal financial security.
Three things to keep in mind when choosing a legal form are:
Liability: Legally, corporations are individual entities. As such, the corporation -- not individual shareholders -- are responsible for the actions of the business. In other words, if something goes very wrong, and a corporation is sued, only the assets of the corporation are at stake -- not the owners' personal assets. (There are some exceptions to this rule, but generally, your personal liability is GREATLY limited.)
Double taxation: No one likes paying taxes, and you certainly don't want to pay taxes twice -- once on income for the business and then again when that income is distributed as profits to you. Instead, look for a legal form that allows for the profits of the company to "pass through" to the owners, without having to pay corporate taxes first.
Ownership: Certain legal business forms limit the number or type of people who can invest in your company. If you're seeking a large number of investors or international investors, find a corporate structure that permits such stockholders.
It's always best to sit down with an attorney -- and possibly an accountant -- to discuss the best corporate structure for your specific business.
When you do meet with an attorney, these are the legal structures you'll consider:
Sole Proprietorship: A business owned by one person with no formal legal structure.
Advantages: It's simple! Just start your business; there's no additional paperwork. You don't file corporate income taxes -- just a Schedule "C" with your personal income taxes.
Disadvantages: You have no personal liability protection. If your business is sued, you could lose everything you own -- and in some cases, your spouse could lose his or her assets also.
Partnership: A business with more than one owner who actively engages in the management of the company.
Advantages: No required legal forms (although you'd be well advised to draw up a partnership agreement). No double taxation -- profits pass through to the partners.
Disadvantages: Each partner has unlimited personal liability, even for actions taken by other partners. Be warned: if you go into business with others, you've got a partnership in the eyes of the law whether or not you've drawn up any paperwork.
Limited Liability Company (LLC): A legal form which provides liability for the company's owners without requiring incorporation. LLCs have become the form of choice for many small companies.
Advantages: Personal liability protection for all owners and pass through profits without corporate taxes. Another benefit: profits can be distributed unequally -- a 60% shareholder can take only 10% of the profits. This allows more flexibility for tax planning and for rewarding owners who bear more management responsibilities.
Disadvantages: LLC laws vary by state; you are likely limited in the number of owners (investors) you can have, and some states do not permit international investors.
"S" Corporation: A type of corporation that provides personal liability but permits pass through taxation.
Advantages: This used to be the most popular choice for small companies, and lawyers and accountants are very familiar with laws relating to S corporations.
Disadvantages: You can not distribute profits unevenly as you can with LLCs. You pay state corporate fees.
"C" Corporation: A corporate form that allows for the most investors and significant liability protection.
Advantages: No limit to the number of people who can own stock. Legal form for companies that are going to be publicly traded.
Disadvantage: Double taxation.
admin
Sizing Up Business Structures
By: Michael J. Oates CPA
The structure you choose for your business affects your business' bottom line.
Figuring out the type of business to open is only half the battle of an entrepreneur. Your choice of business structure will largely determine how your business income will be taxed. The most popular and familiar legal forms of business are C corporations, S corporations and Limited Liability Companies (LLCs).
These may look like just a few simple words on a page, but they could mean thousands of dollars to your bottom line. Many business owners choose S corporations because they provide limited liability, income flow-through to their individual income tax returns and tax-free merger benefits. But like other business structures, S corporations have their disadvantages. If you already have or intend to elect this entity or any other entity, you should understand how they are structured so you can establish a financial plan.
C corporations
With the C corporation, income may be subject to tax at two levels: first, to the corporation at corporate tax rates and then, again to the shareholders when distributed as dividends. Not surprisingly, tax planning for closely held corporations often centers around finding tax-efficient ways to withdraw profits from the company. Traditionally, double taxation has been one of the C corporation's biggest drawbacks.
However, double taxation can be avoided if owners working in the business draw reasonable salaries. The corporation deducts the salaries and the owners pay tax on the amounts they receive. Since the enactment of the Jobs and Growth Relief Reconciliation Act of 2003, the lower rates on dividends have temporarily lessened the impact of double taxation. Owners of closely held companies should consider renewing their compensation/dividend decisions carefully in view of the dividend rate break. In some situations, paying a bonus will result in more overall tax (income and FICA) than paying a dividend.
When incorporating a new small business, consider taking the precautionary measure of qualifying the stock as "Section 1244" stock. If you later suffer a loss on the stock, you would be able to deduct it as an ordinary loss up to $50,000 ($100,000 if married filing jointly), with any excess treated as capital loss. Ordinary loss treatment is a significant advantage because of the limitations on deducting capital losses - they are deductible only to the extent of capital gains and up to $3,000 of ordinary income per year. You should speak with your financial team about this option.
S corporations
Many business owners elect subchapter S status for their corporations to avoid the double taxation issue. S corporations are treated as a regular corporation. When forming S corporations, you must first incorporate under your state law. An S corporation generally does not pay federal corporate taxes. The company passes through its income, losses, deductions and credits to the owners for inclusion on their tax returns. Furthermore, you must designate directors, officers and shareholders who function in the same manner as their regular corporation counterparts. Recent tax laws increased the maximum number of S corporation shareholders to 100 and with only one class of stock. Beginning in 2005, family members (including current and former spouses) are allowed to elect to be treated as one shareholder for purposes of determining the number of S shareholders of an S corporation. Some of the rules for S corporations can be confining, so be sure you can live with these restrictions before deciding to elect S status.
Those currently with C corporations should proceed with caution when deciding to convert to the S election because of the built-in gains tax. This tax applies when a former C corporation sells an asset that had built-in gains when the S election was made. Keep in mind that this is only an issue during the first ten years as an S corporation. Several rules and exceptions apply, so check with your CPA before moving forward.
Limited Liability Company (LLC)
LLCs offer liability protections similar to the corporations. However, LLCs are typically taxed as partnerships. Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities. Unlike the S corporation, there is no maximum number of members in an LLC. Most states also permit "single member" LLCs - those having only one owner. All LLC income, losses, deductions and credits "flow through" to the owners. This means that earnings of an LLC are taxed only once. LLC members may agree to divide these items any way they see fit as long as the allocations have substantial economic effect. This gives the LLC members a considerable amount of tax planning flexibility.
LLCs are popular because, similar to a corporation, owners have limited personal liability for the debts and actions of the LLC. Other features of LLCs are more like a partnership, providing management flexibility and the benefit of pass-through taxation. A few types of businesses generally cannot be LLCs such as banks, insurance companies and nonprofit organizations. Check your state's requirements and the federal tax regulations for further information. There are also special rules for foreign LLCs.
There are advantages and disadvantages to all business structures and understanding the complexities in the tax laws relating to each can be challenging. Before making your decision, be sure to evaluate the pros and cons of each entity type with a business consultant or CPA to determine which structure makes the most sense for your business.
SIDEBAR: New S Corporations Rules
Beginning in 2005, the American Jobs Creation Act of 2004 (the Act) allows suspended losses to be transferred with transfers of S stock to a spouse or former spouse incident to divorce.
For distributions after 1997, the Act permits an S corporation to use distributions on stock held by its Employee Stock Option Plan (ESOP) to repay loans, provided the stock of at least equal value is allocated to participant accounts.
The Act allows an IRA to hold S corporation bank stock that the IRA held on the enactment date with the IRA owner treated as the shareholder and allows the stock to be sold to the beneficiary for fair market value upon the corporation making an S election.
Beginning in 2005, the Act disregards unexercised powers of appointment in determining potential current beneficiaries of a special type of trust for holding S stock known as electing small business trust (ESBT), and increases the period during which a trust can dispose of stock after an ineligible shareholder becomes a potential current beneficiary from 60 days to a year.
Michael Oates is a certified public accountant and tax principal with Rothstein Kass-Certified Public Accountants (www.rkco.com), one of the top 20 largest international accounting and consulting firm based in the U.S. He regularly work with entrepreneurial companies in various industries.
admin
Acronym Acrimony
Acronym Acrimony
By: Melanie Warner
Along with naming your company, deciding which entity your business should become is one of the first decisions you'll ever make.
The decision to start your own business all comes down to a series of three little letters: Inc, LLC and LLP. Along with naming your company, deciding which entity your business should become is one of the first decisions you'll ever make. And it's an important one. "You really want to think it through and understand what's right for you," says Mark Williams, director of operations at Business Filings, a company that provides incorporation services for small businesses.
The differences among the three business structures -- corporations, limited liability companies and limited liability partnerships -- are worth pouring over because they will determine how your business evolves -- the way in which you structure ownership, whether you can raise capital and, of course most importantly, how much you pay Uncle Sam on tax day.
Inc. -- Setting up as a corporation
The majority of businesses in the United States (both small and large) are formed as standard C corporations and have the Inc. moniker following their names. And there's good reason for this. C Corporations give their owners enormous flexibility in how they operate their businesses, the way they distribute ownership and how they raise capital. They also afford owners and managers significant protection from legal liability. If someone sues your business, generally speaking, your house and livelihood won't be on the line. And vice versa. If you get into trouble with personal debt, creditors, by and large, won't be able to come after your business.
But corporations aren't for the slight of heart. They're complicated structures that require a lot of paperwork and organizational discipline. Chip McClelland, a business, tax and financial consultant in Honolulu, says he's had to undo incorporation for more than a few small business clients who didn't know what they were getting into.
One way to make the process of being a corporation a little simpler is to convert it to an S corporation. This is done by filing Form 2553 with the IRS by March 15 of the year in which you want to be eligible. As an S corporation you will not have to pay taxes on the earnings of your business, avoiding the double taxation whammy of C corporations. Since the income of an S corporation is "passed-through" to shareholders, you pay taxes only on this personal income. Yet, keep in mind that S corporations still require all the formality of C corporations -- by-laws, articles of incorporation, boards of directors, annual meetings, and required employment contracts for officers and owners.
There are also specific rules and restrictions involved in being a tax-free S corporation. Much of the flexibility you get with a C corporation is gone. You can't have more than 75 shareholders, and these shareholders must be individuals (not other corporations or trusts) and can't be non-resident aliens. You also can't do anything fancy with your company's stock; only one class of stock is allowed -- no preferred shares with special liquidation, dividend, or conversion rights.
LLC -- Limited Liability Company
If these S corporations restrictions seem too limiting but you like the tax advantages, you might want to think about incorporating your business as an LLC. A business classification that's been gaining popularity in the last 10 years, LLCs offer many advantages to small business owners. Business Filings reports that half their clients choose to incorporate as LLCs.
A slimmed-down alternative to the corporation, LLCs have the same so-called "limited liability" protection as corporations, but none of the costly bureaucratic hurdles. In many states LLCs also have lower formation and renewal fees.
Similar to S corporations, income generated by an LLC flows to its owners, who are referred to as "members." However, there are no limits on the numbers of such members or the company's organizational structure. LLCs can form subsidiaries and offer several classes of "membership interest," or stock. And last year LLCs became eligible for the deduction of 100% of health insurance premiums, just as corporations have been able to do for years.
The main disadvantage of LLCs is that raising capital isn't easy. Doing a public offering, for instance, is nearly impossible. This is because ownership interest in an LLC is not freely transferable. Owners must obtain approval of the other owners before interest can be sold. If you're a business owner with dreams of one day pulling off an IPO, forming a C corporation is probably your best bet.
LLP -- Limited Liability Partnership
Historically partnerships have been the province of law and accounting firms, and today that's still largely the case. Yet because of emergence of LLCs there are few advantages these days to being an LLP. The pass-through tax advantages of partnerships can now be found in both LLCs and S corporations, yet LLPs lack the liability shield afforded by LLCs and corporations. In a partnership every owner, or partner, is legally responsible for the actions of the company.
LLPs are, however, ideal for short-term projects, like a condo development with multiple investors, since they can be disbanded easily.
Much of the decision over business entities comes down to what you want your company to be when it grows up. Deciding that at the start can set your business off on the right track and prevent a lot of headaches down the road
