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Choice of Business Entity. Jack Cohen, CPA Asset Protection IncSmart.biz Inc. Types of Entities. C CORPORATION. S CORPORATION. LLC. PARTNERSHIP. SOLE PROPRIETOR. Identifying the Objectives Items To consider What’s at Risk?. Tax Savings Asset Protection Management

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slide1

Choice ofBusiness Entity

Jack Cohen, CPA

Asset Protection

IncSmart.biz Inc

types of entities
Types of Entities

C

CORPORATION

S

CORPORATION

LLC

PARTNERSHIP

SOLE

PROPRIETOR

identifying the objectives items to consider what s at risk
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
Chances of IRS AuditF.Y. 06
  • Form 1040 Sch. ‘C’ > $100,000 = 3.90%
  • 1120 < 10 Mill. Assets = .80%
  • 1120-S = .38%
  • 1065 = .36%
tax savings
Tax Savings
  • Income Tax
  • Payroll Taxes
  • Self Employment
  • Gift and Estate Taxes
asset protection from
Asset Protection From:
  • Business Activities Risk
  • Management Actions
  • Employee Actions
management
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
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 company- member 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
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
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
Proprietorships – Non Tax Considerations
  • Simplicity of form
  • Unlimited personal liability
  • Continuity of existence and transferability of ownership
  • Limited ownership
proprietorships tax considerations
Proprietorships – Tax Considerations

Tax Advantages

  • Wages paid to children
  • At-risk rules
  • Fringe benefit via spouse employment
  • No double taxation

Tax Disadvantages

  • Self-employment tax
  • All income taxed at individual level
  • Lack of fringe benefits
  • Hobby loss rule
proprietorships taxation
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
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
Real Estate Tip
  • For Maximum Asset Protection Separate SMLLC for each property.
  • Put Real Estate in SMLLC.
partnership formation issues
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
Partnership – Tax Considerations

Tax Advantages

  • Tax basis from debt
  • Basis adjustment when partnership interest acquired
  • Tax-free contributions and distributions of property
  • Ability to make special elections
  • No entity level of tax

Tax Disadvantages

  • Inability to reduce payroll taxes
  • Unfavorable tax treatment of fringe benefits
  • Lack of flexibility to select a tax year end
  • Technical Termination
partnership taxation summary
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
S Corporation – Tax Considerations

Tax Advantages

  • No double taxation
  • Pass-through to shareholders
  • No excessive compensation
  • Ability to reduce payroll taxes
  • Ability to use cash method
  • Tax-free withdrawals of equity
  • Possible ordinary loss treatment for stock losses

Tax Disadvantages

  • Fringe benefits
  • Tax year-end
  • Built-in gains tax
  • Excess passive income
  • Basis is reduced even if no tax benefit
s corporation who can be shareholder
‘S’ CorporationWho 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
‘S’ CorporationWho 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
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
Partnership vs. S Corp– Treatment
  • Social Security
      • General partners pay FICA on K-1 income
      • Shareholders S Corp K-1 income: no FICA
social security how much does sub s owner pay
Social SecurityHow 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 treatment1
Partnership vs. S Corp – Treatment

Distributions

  • Partnership: disproportionate distributions allowed
  • S Corp: no disproportionate distributions

Ownership Interest

  • S Corp: ownership restricted
  • 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
C Corporations – Non Tax Considerations
  • Limited liability
  • Administrative burden
  • Management and control
  • Continuity of existence and transferability of ownership
c corporations tax considerations
C Corporations – Tax Considerations

Tax Advantages

  • Lower tax rates at many income levels
  • Net income not subject to Social Security
  • Takes maximum advantage of fringe benefit deductions

Tax Disadvantages

  • Double taxation of corporate earnings
  • Excessive compensation
  • Personal service corporate limitations
  • Personal holding company accumulated earnings tax- penalty taxes
  • Limitations caused by corporate ownership changes
c corporation employee benefits
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
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
slide31

THANK YOU

For more information, visithttp://incsmart.biz