Choosing a Business Entity Type
The Advantages and Disadvantages of Incorporating as a
Subchapter S Corporation, C Corporation, Limited Liability
Corporation or Partnership
When looking at what type of entity your business should be, we
strive to balance the legal protection issues vs. the tax
savings. Over the years, we have developed the mindset that
there is no perfect election but there are ones that are better
than others.
The information below and the assumptions we make are based upon
the fact that my clients tell me that they want to pay as few
tax dollars as legally possible. Below are some very specific
rules, as well as some generalities. If you are considering
incorporating in Georgia, we suggest that you sit down with a
tax professional to see how these guidelines relate to you.
About S Corporations
Subchapter S Corporations can have no more than seventy-five
shareholders and they all need to be U.S. citizens or resident
aliens. This corporation type almost always has to have a
calendar year as the fiscal year. S Corporation rules have been
around since the 1950s and were set up to simplify the rules and
regulations of being a business owner.
Liability Protection and Subchapter S Corporations
A subchapter S Corporation, like a C Corporation, affords the
business owner personal liability protection from business
risks. Some of the keys to maximizing that protection is to
treat the corporation like one by doing all your business in the
corporate name, signing all of your documents listing your
corporate title, not co-mingling any personal issues/bills in
the corporation, and by having your annual Board of Directors
and Annual Shareholder Minutes Meeting.
Tax Advantages of S Corporations
No income taxes are paid with the corporate return. The profits
of the business are reported on the personal tax return of the S
corporation's shareholders. As long as you pay yourself a
reasonable salary, you may also take shareholder distributions
out of the business that are devoid of FICA/Medicaid taxes.
Another advantage of S Corporations is that if you have
corporate losses, and you fund (you put the money in the
business) those losses personally, then you can deduct those
losses on your personal return. Any losses that are funded by
the bank (a direct loan from the bank to the corporation) or by
trade creditors are not deductible.
Often you can set up a loan so that the bank lends to you
personally and then you could do a personal loan to the company
which will result in you having contributed basis/the dollars to
the business, thus making any losses that you fund deductible.
If you would like to learn more about S corporations and their
advantages, please
contact us.
About C Corporations
This type of corporation is perfectly set up for those to whom
do not qualify to be an S Corporation, such as a public held
company that has thousands of shareholders, lots of classes to
stocks, and sells its stock to anyone (corporations,
individuals, retirement plans, etc).
Taxation of C Corporations
A C Corporation pays taxes on all its profits first at the
corporate level and then when the dollars are paid out to the
owners in subsequent years, the owners pay tax again at the
individual level. C Corporations, therefore, are exposed to a
"double taxation" that none of the other entity types are
exposed to. If you think taxes are bad enough paying them once,
try paying them twice. OUCH!
Converting from a C to an S Corporation
A C Corporation can make a timely tax election to become an S
Corporation and start taking advantage of tax advantages of
being an S Corporation. Care should be taken to ensure that all
shareholders understand and agree to become an S Corporation and
that there are no or relatively insignificant net operating
losses that might still be utilizable if you were to stay a C
Corporation.
Then after these are utilized/considered, we would effect the
change.
About LLC's, LLP's and Forming a Partnership
Limited Liability Corporations (LLCs), Limited Liability
Partnerships (LLPs) and General Partnerships are all taxed in
the same manner. Choosing one of these types as a business
entity would be a poor selection for a business such as a print
shop, as they will all result in higher taxes with no additional
advantages for the printer.
we have developed a mindset that if you do not need to be
another entity type then you need to be an S Corporation. For
example, generally speaking a printer that was an LLC, LLP, or
Partnership will pay higher taxes with no additional advantages
as opposed to being an S Corporation. A Limited Partnership is
also an option that could be explored when certain partners want
to limit their liability and exposure.
Below are some of the reasons you might want select an LLC or
LLP as your entity choice:
- If you were a lawyer or physician's practice
then all of the partners' personal assets are at risk if one
partner does something wrong, while if an LLC or an LLP, only
the offending partners personal assets would be at risk. This is
because of the professional service statutes for these type of
professionals, but these rules do not relate to our printer.
- If you were an real estate developer and you
had a piece of land that had dramatically increased in value,
you can transfer that property to an LLC, LLP, or Partnership
without having to pay any capital gains tax. Also with these
entity types, you can take shareholder distributions that are
not based upon ownership, whereas in an S or a C Corporation
they have to be. Again, this does not relate to our printer
client.
If you have set up as one of these entity types, it might be
advantageous to consider a tax-free merger into an S Corporation
which will allow you to retain all the legal contracts, etc. of
your present entity while switching to the tax advantages of
being an S Corporation. If you would like to set up a meeting to
discuss these issues and your personal tax situation in detail,
please feel free to
contact us. If you know
anyone looking for a Good CPA, please suggest they visit our
web-site.
The Tax Effects of Entity Choice
Among the different ways of incorporating your business — C
corporations, S corporations, and Limited Liability
Corporations — there are practical reasons for choosing a
given method, such as the number of shareholders or
liability considerations. For many small business who are
considering incorporating in Georgia, the tax advantage of
the S corporation should not be overlooked.
Tax Advantages of S Corporations
As a LLC, LLP, partnership or sole proprietorship, you are
subject to the 15.3% Self Employment/FICA tax on all of your
net earnings. The S corporation, on the other hand, pays you
a deductible salary (which is subject to FICA), and then the
profits flow through your personal return via a Schedule
K-1. This K-1 income allows for permanent deferral of the
FICA tax. The S corporation allows small business owners to
legally save taxes as long as they pay a fair and reasonable
salary to themselves.
Please take a look at the following comparison. It shows the
tax effects on a single year's income for a LLC, LLP,
partnership, or sole proprietor vs. a C corporation, and
compares it to a subchapter S corporation. Due to the way C
corporations are exposed to double taxation, the payments
are spread out over two years, which is not the case for
partnerships or S corporations.
| |
LLC, LLP, Partnership,
Sole Proprietorship |
C Corp. |
S Corp. |
| Income |
$180,000
|
$180,000
|
$180,000
|
| Expenses |
($100,000) |
($100,000) |
($100,000) |
| |
|
|
|
| Gross Profit |
$80,000
|
$80,000
|
$80,000
|
| Salary to Owner |
$0 |
($40,000) |
($40,000) |
| Taxable Income |
$80,000
|
$40,000
|
$40,000
|
| Entity Tax |
$0 |
$6,000
|
$0 |
| |
|
|
|
| First Year |
|
|
|
| FICA/SE (15.3%) |
$12,240
|
$6,120
|
$6,120
|
| Federal & State Income Tax
(25%) |
$20,000
|
$10,000
|
$10,000
|
| Tax on K-1 Profits (25%)
|
$0 |
$0 |
$10,000 |
| Total Tax |
$32,240
|
$16,120
* |
$26,120
|
| |
|
|
|
| Second Year |
|
|
|
| FICA/SE (15.3%) |
$0
|
$5,202
|
$0
|
| Federal & State Income Tax
(25%) |
$0 |
$8,500
|
$0 |
| Total Tax |
$0
|
$13,702
* |
$0
|
| |
|
|
|
| 2 Year Tax |
$32,240 |
$35,822 |
$26,120 |
Difference between Proprietorship and S Corporation
$32,240 - $26,120 = $6,120
* 1st year is tax on W-2, 2nd year is tax on $34,000
($40,000 prior year taxable, less $6,000 paid during the
first year)
Please note this representation is only an example. It is
being used for demonstration purposes, it does not take into
consideration exemptions, deductions, fling status or any
other significant tax matters. Your situation may not yield
the same results. Please contact a tax professional before
making any financial decisions.
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