The most common business entity for the self-employed is the S Corporation. The primary advantage of an S Corporation is that the profits and losses pass through to each shareholder’s tax return. (only one level of tax to pay), you are taxed once on profits and can utilize a loss immediately (or carry back/forward). Shareholders of the S corporation should be paid a reasonable salary (subject to payroll taxes), however, profits beyond this salary may be distributed to the shareholders (not subject to payroll taxes).
As a corporate officer/owner of an S Corporation, you want to ensure you know the following information:
- Shareholder Basis at the end of every year
- The basis of all corporate assets
- Financial Position (Balance Sheet)
- Result of Operations (Profit & Loss)
- Status of deferred compensation plan and amount that can be funded for the current year.
To be treated as an S Corporation, the election (form 2553) must be filed within two months and fifteen days after formation. Late election relief is possible, but should not be relied upon.
To qualify for S corporation status, the corporation must meet the following requirements:
- Be a domestic corporation
- Have only allowable shareholders
- including individuals, certain trusts, and estates and
- may not include partnerships, corporations
- or non-resident alien shareholders
- Have no more than 100 shareholders
- Have one class of stock
- Not be an ineligible corporation i.e. certain financial institutions, insurance companies, and domestic international sales corporations.
Corporations have their own set of rules on gains and losses, and deductibility of expenditures. S Corporation shareholders only get a “basis” for the loans they make to the Corporation (with appropriate promissory notes) and the capital they invest. They do not get basis through a third party guarantee of debt or any other recourse debt of the Corporation.
Common important tax transactions for a small domestic corporation are when assets are contributed or distributed, sales or exchanges of shareholder stock (changes in control), like-kind exchanges, and dissolution. If a corporation operates in various states (venue), state returns will need to be filed.
Discuss all transactions with your CPA (me) before entering into them to structure them for the greatest tax benefit.
Corporations, at a minimum, need to keep bylaws, articles of incorporation, recorded minutes of meetings, and resolutions for the “Corporate Veil” to not be pierced (i.e. to retain limited liability for shareholders).
C Corporations have various benefits that S Corporations do not offer; however, in most cases, a small business is better off utilizing the S Election. If you wish to discuss the benefits of a C Corporation (fringe benefits, reinvesting earnings for growth, different classes of stock, types of shareholders, multi-state income, etc), make an appointment with us.
LLC
This is the choice of entity for entities that want to be treated as a partnership (by default) with limited liability for members regarding personal asset protection and responsibility for obligations of the LLC.
In order for an LLC to file a partnership return (1065), there must be at least 2 members, otherwise, it is a disregarded entity (filed on the sole member’s tax return). A one-member LLC can also choose a tax entity status of being a C corporation (form 8832), or filing an S election (form 2253) and filing as an S Corporation. This allows for corporate income tax treatment without the paperwork of running a corporation. It is highly recommended that if you plan to run a one-member LLC as an S Corporation that you form a corporation instead.
As an LLC member you want to ensure you know the following information:
- Member Basis at the end of every year.
- The basis of all LLC assets.
- Financial Position (Balance Sheet).
- Result of Operations (Profit & Loss).
- Status of deferred compensation plan and amount that can be funded for the current year.
- LLC member income (due to active trade or business) is almost always self-employment income, with the exception of certain non-managing non-working members (equivalent to limited partners). The LLC profits and losses flow through to the individual tax return of each member.
An LLC filing as a partnership is by far the best option for holding real estate, as each member/partner receives a “basis” for the qualified non-recourse debt (i.e. a mortgage) as well as any other form of recourse debt of the LLC/partnership.
Common important tax transactions for small domestic LLCs are when assets are contributed or taken out, sales or exchanges of a partnership interest, profit/loss special allocations and distributions, and liquidation/dissolution.
An LLC needs to have articles of organization (an operating/partnership agreement) but does not need to hold Annual General Meetings and keep a record of its Minutes.
Partnership taxation offers the most flexible, and complex form of tax rules. Discuss all transactions with your CPA (me) before entering into them in order to structure them for the greatest tax benefit. Partnership agreements that are other than standard should be created or reviewed by an attorney to ensure legality and enforceability.
