Tax Topics:

Business Due Dates: Reminders for business owners. Click here.

Business Issues & Tips: Click here.

Tax Tips of the Month: Click here.

Quickbooks Tips: Click here.

New & Updated Tax Laws: Click here.

Cutting Your Taxes: Learn how to reduce your tax burden.
Click here.

Homeowners: Understand the tax benefits of homeownership.
Click here.

Itemized deductions: Must know deductions for every taxpayer.
Click here.

Recordkeeping: Must know tax saving
tips for every taxpayer. Click here.

Seniors: How to keep more of your
retirement savings . Click here.

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This quarter's education topic is about
"Choosing Your Legal Structure."

Choosing Your Legal Structure:

Part of keeping a home-based business legal involves choosing the legal structure for it: Sole Proprietorship, Partnership, or Corporation. Aside from being necessary for government reporting and tax purposes, this can enable your business to operate more efficiently since each legal form has it’s own unique characteristics, your goal is to choose the form that works best for you.

Sole Proprietorship:

A business owned by one person, who is entitled to all of its profits and responsible for all of its debts, is considered a Sole Proprietorship. This legal form is the simplest and it is often the suggested way for a new business that does not carry great personal liability threats. The owner simply needs to secure the necessary licenses and Tax ID numbers.

 

Advantanges: You’re the boss It’s easy to get started You keep all profits Income from business is taxed as personal income You can discontinue your business at will. The life of the business is dependent on the owner’s

Disadvantages: You assume unlimited liability The amount of investment capital you can raise is limited You need to be a generalist Retaining high-caliber    employees is difficult.

 

Partnership:

A business owned by two or more people who agree to share in its profits, is considered a partnership. Like the Sole Proprietorship, it is easy to start and the red tape involved is usually minimal. The tax structure is the same as a sole proprietorship except the profit and losses of the partnership are divided by an agreed percentage by the partners and it requires filing a separate tax return.

It is advisable for your own protection to have a written partnership agreement that will spell out the specifics of the agreement. This should state (1) each partner’s rights and responsibilities (2) the amount of capital each partner is investing in the business, (3) The distribution of profits, (4) what happens if a partner joins or leaves the business, (5) how the assets are to be divided if the business discontinued. Things have a way of changing and people forgetting over time, so it is essential that there be a signed document that all abide by. However, the partnership is generally the least advisable way to go.

 

Advantages: Two heads are better than one. It’s easy to get started. More investment capital is available. Partners pay only personal income tax. High-caliber employees can be made partners.

Disadvantages: Partners have unlimited liability. Partners must share all profits. The partners may disagree. The life of the business is limited. You are responsible not only for your own business debt but for those of your partners as well.

Corporation:

A corporation differs from the other legal forms of business in that the law regards it as an artificial being possessing the same rights and responsibilities as a person. This means that unlike sole proprietorships or partnerships, it has an existence separate from its owners. It has the legal rights of an individual in regards to conducting commercial activity – it can sue, be sued, own property, sell property and sell the rights of ownership in the form of exchanging stock for money. The owners must bear the ongoing cost of preparing and filing cost of preparing and filing the state and federal reports.

 

Advantages Stockholders have limited liability. Corporations can raise the most investment capital. Corporations have unlimited life. Ownership is easily transferable. Corporations utilize specialists. Limited liability.

Disadvantages C Corporations are taxed twice Corporations must pay capital stock tax. Starting a corporation is expensive. Corporations are closely regulated by Government agencies More experience to start

 

C Corporation:
With a C Corporation, is a separate taxable entity and you will pay tax on the income at the corporate rate. Dividend distributions are taxable to the shareholder. C Corporations can provide certain fringe benefits for their owner/employees that are deductible for the corporation and not taxable to the shareholder. However, because of the lower corporate rates on the first $75,000 of taxable income, the C corporation may be advantages for a business that wants to retain cash.

S Corporation & LLC:

S Corporations and Limited Liability companies (LLCs) are similar. Both are pass through entities from a tax standpoint. That avoids the double taxation of C-corporation dividends. An S corp. must follow the same formalities and record keeping procedures as a C corp. The directors or officers of an S corp. manage the company and the profits are split up amongst its shareholders. The profits must be distributed according to the ratio of stock ownership even if the owners feel it is more equitable to distribute the profits differently. However, in order to qualify for S status, your business must meet the specific requirements set forth by the IRS. These include limits on (1) the number of shareholders in the business, (2) the stock that is issued, (3) the corporation’s sources of revenues.

LLCs offer greater flexibility in ownership and ease of operation. There are no restrictions on the ownership of an LLC. An LLC is simpler to operate because it is not subject to the formalities by which S Corps must abide. An LLC can be member-managed, meaning that the owners run the company; or it can be manager-managed, with responsibility delegated to managers who may or may not be owners in the LLC. The owners of an LLC can distribute profits in the manner they see fit.

Points you might want to consider when selecting between a LLC and an S-corporation?

1.) Cost/ease to establish the business structure. S-corporations can usually be established as inexpensively as LLCs. LLCs often spend money in attorney fees to develop a proper membership agreement. But, both structures can be formed with the assistance of your tax preparer or legal counsel.

2.) Ease of on going administration. Corporations are more formal. You’ll need to maintain corporate minutes and document corporate actions. Once you’re familiar with the process, documenting corporate actions isn’t that difficult.

3.) Self-Employment/Employment Tax Issues. Members who are active in running a LLC need to pay employment tax on their earnings. In an S Corporation, only the salary paid to the employee is subject to employment tax. The remaining income that is paid as a distribution is not subject to employment tax under the IRS rules. Therefore, there is the potential to realize substantial employment tax savings. This is discussed more in detail in “How To Start and Run Your Own Corporation: S Corporations For Small Business Owners.”

In practice, the IRS is careful to notice whether a salary is reasonable by industry standards. If it determines a salary to be unreasonable, the IRS will not hesitate to reclassify distributions as salary. Still while the potential employment tax savings may make the S corporation an attractive structure for your business, bear in mind that you would then have to deal with all the paperwork associated with payroll tax. The payroll tax is a pay-as-you-go tax that must be paid to the IRS regularly throughout the year-on time, or you will incur interest and penalties. The paperwork alone can be an overwhelming task for someone who is not familiar with this; and it is best to work with a professional who can assist you with payroll matters.

4.) Flexibility of structuring financing arrangements. LLCs offer more flexibility as to how ownership and return can be structured than does a typical S-corporation. However, the S Corporation structure seems to offer adequate financing capability for most entrepreneurs. (However, in some cases, a LLC will work better. For example, if you have a non-resident aliens as investors, a LLC is preferable at present, due to restrictions on who may own shares in an S-corporation.)

5.) Owners of LLCs pay self-employment tax on their earnings once a year on April 15th when income taxes are due. Income taxes filings are also relatively easy for the owners of an LLC: A single member LLC files the same 1040 tax return and Schedule C as a sole proprietor; partners in an LLC file the same 1065 partnership tax return as do owners of traditional partnerships.

6.) All corporations must pay a minimum tax to the state of California. Minimum tax is the amount you must pay the first quarter of each accounting period whether the corporation is active, operates at a loss or does not do business. The current minimum tax is $800. For new corporations that qualify or incorporate after January 1, 2000, the minimum tax is $0.00 for the first tax year, but is measured based on income for the year and is subject to estimate requirements and $800 minimum tax for subsequent years. S corporations must pay at least the minimum tax each year. LLC’s pay the minimum tax of $800 or fee a fee based on the gross income of the LLC.