Presentation Transcript

1. Choice of and Formation of Entity

2. Choice of and Formation of Entity
3. Your Entity: A Plan for the Future How will you grow your business? 2 4 1 3
4. Your Entity: A Plan for the Future 6 8 5 7
5. Chapter 1

   Types of Entities

6. Why Use an Entity? More than one owner Separation of ownership from control Ease of raising capital Protection from liabilities
7. General Entity Choices Corporation S Corporation The corporation’s shareholders file an election for the corporation to be taxed as an S Corporation. Once effective, the entity’s taxable income is taxed on the shareholders’ return. Professional-service corporation A corporation where owners perform significant professional services Taxed differently than a regular corporation or an S Corporation Can elect S Corporation status
8. General Entity Choices General partnership Partners are jointly and severally liable for Partnership debts Can be formed without formal agreement (although not recommended to do so) Limited partnership At least one general partner who actively manages the business and is liable for the Partnership’s debts At least one limited partner who only risks their contribution and is unable to participate in management Limited liability partnership (LLP) Offers partners liability protection but with ability to participate in management Readily available for professionals
9. General Entity Choices Limited liability company (LLC) Members (Owners) generally liable only for amounts contributed Members can agree to guarantee debt of the LLC Single member LLC (SMLLC) Owned by any taxpayer Qualified Subchapter S Subsidiary (Qsub) Wholly-owned by an S corporation Fiction of federal tax law and formed under corporate law in any state
10. Series LLCs Defined as a segregated group of assets and liabilities that is established pursuant to a statute by agreement of a series organization Cell Segregated account Segregated portfolio Formed under insurance code engaged in insurance business Relatively new entity in a few states Certain entities may establish a series Series LLCs under an entity are not treated as separate entities for state law purposes
11. Series LLCs State classification is not controlling for federal tax purposes Each series LLC within the overall entity can Act like a separate unit with regard to conducting business, contracting, borrowing, etc.
12. Series LLCs Proposed federal tax guidance permits Members of series to have rights, powers or duties Series to have separate rights, powers or duties for specified property or obligations Segregation of assets and liabilities from other of the series Treating domestic series as entities is more appropriate than disregarding the series as separate from the overall entity Does not detail how a series should be treated for Federal employment tax purposes
13. Chapter 2

    Entity Formation and Election

14. General Formation Rules Can usually form an entity in a tax-free manner if structured properly Exit, however, can have a high tax cost if the wrong entity is selected It helps to know the destination before beginning the trip
15. General Formation Rules Most entities require filing paperwork with the state (except proprietorship or GP) Do not engage in the practice of law if not an attorney (i.e., do not draft partnership agreements, trust instruments, or articles on incorporation for clients) Important to proof attorney’s documents to ensure they meet the owner’s needs
16. Corporation Formation Aspects Comply with state law Tax-free if rules are followed under Section 351 Take heed of property contributions with liabilities Transfer of ownership interests in return for services Basis carryover for contributions of property
17. S Corporation Formation Aspects Generally follows C corporation rules Affirmative election by all shareholders permits the taxation of income to pass through to them Versus taxed to the corporation and then to them (double taxation) Ensure that S qualification criteria continue to be met over life time Potential tax traps upon conversion from C to S corporation
18. Partnership & LLC Formation Aspects General partnerships – Formal or Informal LLCs and LLPs – must comply with state law Tax-free contributions under Section 721 Basis carryover on assets transferred Partners can transfer liabilities with related assets, but be careful of disguised sale rules
19. Chapter 3

    Exploring Entity Options

20. General Tax Options * An LLC with a single owner will be disregarded for federal tax purposes.
21. Converting from C to S Built-In Gains Tax (BIG) BIG is the appreciation in an asset at the date of the S election BIG tax is triggered if applicable assets are sold or distributed within 5 years from the date of the S election LIFO Recapture Benefits derived from this method while a C corp are taxed over four years Passive Income Special tax if the S has investment type income > 25 % of gross receipts Unused Losses NOLs cannot be used as an S corp
22. BIG Recognition Period Five years for conversions occurring in tax years 2011 – 2013 Seven years for conversions occurring in tax years 2009 - 2010 10 year recognition period for all other tax years
23. Recognized Built-in Gain Items subject to the built-in gains tax include any item of income that is taken into account during the recognition period if the item is attributable to the period prior to the effective date of the S election Thus cash basis accounts receivable earned by the C corporation, but collected by the S corporation, cause built-in gains
24. Converting from S or C to K No special conversion rule Liquidate and re-form Merge into new LLC taxed as corporation; wait 60 months to elect Subchapter K
25. Checklist for Tax-Wise Entity Choices Will the business own appreciating assets? Distributing appreciated assets out of a C or S corporation will trigger tax, so in this case Subchapter K should be considered. If those assets are expected to be sold (rather than distributed), Subchapter S would be a better choice than Subchapter C because there will only be one level of tax and it will be at capital gain rates. Are special allocations of income desired (i.e., allocations other than by percentage of ownership)? If so, Subchapter K would be the best choice.
26. Checklist for Tax-Wise Entity Choices Is flexibility desired with respect to the tax year? Subchapter C allows any tax year, whereas the choice of tax year is greatly restricted under Subchapters S and K (unless a natural business year can be demonstrated). Will the business provide services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting performed by stockholders? If so, the flat corporate tax rate applicable to personal service corporations would indicate that Subchapter C should be avoided.
27. Checklist for Tax-Wise Entity Choices Will all earnings be paid out of the company as salary? Assuming the salary is reasonable, double taxation (and personal service corporate tax) under Subchapter C will not be an issue and greater access to tax-free benefits (including retirement benefits) may mitigate in favor of Subchapter C.
28. Chapter 4

    Other Considerations for Choosing an Entity

29. Owner Salary & Self-Employment Tax Issues Under compensation of owner/employee to save SE tax can be challenged by the IRS Lack of clarity for self-employment tax treatment of LLC members pass through income Is it subject to SE tax or not? Partnership regulations as applied to an LLC are not adequate since LLC members have both liability protection and the ability to engage in entity management Proposed regulations are not in force, but there is no other real guidance
30. Implications of Retirement Plans Rough parity across entities Differences for self-employed – Partnership, LLCs Corp, Sole Proprietorships SEP – Can adopt as late as extended due date of tax return SIMPLE may be most cost effective – low employer contributions required Defined Benefit Plans for cash-cows with only family and future owners as employees
31. Fringe Benefit Considerations Sole proprietors, partners, and >2% S Corp shareholders are not provided the same tax-free treatment for fringe benefits as C Corp shareholders, however the net tax result is the same for health insurance. For example: S Corp pays health insurance for >2% shareholder: S-corp deducts the cost of the shareholder’s health insurance on Form 1120S, This cost is added to shareholder’s W-2 as taxable income, not subject to FICA, and The shareholder deducts this cost on line 29 of their Form 1040 as self-employed health insurance .
32. Case Studies Reedy Hardy: Real Estate Developer Johnson Family Business

33. Questions, Wrap-Up, and Key Points/Lesson Review

34. Choice of and Formation of Entity

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