Choosing
the right legal format of ownership of your successful business venture, mainly
for tax benefits and personal protection
(Please
note that this material is primarily applicable to the USA but the points outlined
have relevance in most countries of the world)
Because
most owners believe they must choose one legal entity, many do not take advantage
of the many features and benefits that other entities afford. By understanding
the tax benefits of each categorization, business owners can save money and grow
their company.
Inevitably, when meeting with a business owner, among the first issues to arise
is that of the business structure. Most business owners profile their company
as a certain type of entity such as a Limited Liability Company (LLC), S-Corporation,
C-Corporation, or Limited Partnership. ( Note that in South Africa and Australia
the LLC is equal to the (Pty) and the S-Corp is equal to the Close Corporation,
CC) Typically they feel confident in the fit of their chosen entity. It's
interesting, however that their reasoning is not always entirely correct, and,
oftentimes it's apparent the owner is not familiar with all of the options available.
For more information of how to "incorporate" your business, click
here
For
a business owner to fully admit that they don't understand why they use a certain
entity over another is not unusual. Some offer weak reasoning for their choice.
For example, "My CPA (accountant) says that this is the best entity available
for such and such reason." Or, "My attorney compared and contrasted
the best two entities and for me, this one is the best." The particular
business categories may have made sense in the beginning, but business owners
oftentimes realize they have outgrown the entity with which they started.
Because
most owners believe they must choose one entity, many do not take advantage of
the many features and benefits that other entities afford. By understanding the
tax benefits of each categorization, business owners can save money and grow their
company.
It
takes a different mindset to fully understand multiple entity structuring. However,
business owners that own more than one business may be utilizing the strategy
without even recognizing it. For instance, a business owner may have two companies
one that is a S-Corporation which allows him /her to utilize the self-employment
tax savings, while the other business is structured as a C-Corporation which allows
the owner to utilize medical benefits.
It
is important to understand that each business situation differs and it's a good
idea to consult a qualified tax advisor before utilizing multiple entity structuring.
For more information on tax services available. click
here
Although
it has been in existence for 10 years in the USA, the LLC is the newest entity
available.. One of the main advantages of the LLC is that it is taxed according
to partnership law. LLC's do not pay taxes. LLC's file an information return
(Form 1065) and all profits are reported on each member's own personal
1040 Form, according to ownership percentage. Another advantage of LLC's is
they can be owned by other entities. Under most circumstances the members involved
in the day-to-day running operations must recognize the income as earned income
and pay the 15.3% self-employment tax.
The
S-Corporation, like the LLC, is taxed like a partnership. S-Corporations
file an information return (Form 1120S) and profits are reported on each shareholder's
own 1040 Form, based on ownership. The main advantage of the S-Corporation
is that a business owner can draw income from the company. Business owners
may take a "reasonable " salary and distribute the rest of the
profits as stock dividends. Usually, the dividend distribution is exempt from
the 15.3% self-employment tax. One major disadvantage of the S-Corporations is
that only individuals {not other entities} or certain types of grantor trusts
may own stock in the company.
The
C-Corporation is the only entity that actually pays taxes. This entity
files Form 1120 and is taxed according to a different tax table than individual
members. The primary advantage of C-Corporations is their ability to provide
tax-deductible benefits. These benefits are usually not entirely deductible in
the other entities, but dividends are from 2003.
Another
main advantage of the C-Corporation is its lower tax bracket. The first
$50,000 that a C-Corporation earns pays only 15 percent in federal income
taxes. This can be extremely beneficial to a business owner that has expenses
that are not deductible.
The
primary disadvantage of the C-Corporation is how dividend distributions
are taxed. Because dividends are paid after the corporation has paid taxes on
its profits, double taxation occurs since the owner of the stock also pays taxes
on the distribution. (This falls away during the 2003 tax year) Another disadvantage
of the C-Corporation is that there are few ways to access retained earnings
without incurring the double taxations discussed above.
The
Limited Partnership, like the LLC and S-Corporation is also taxed like a partnership.
It files an information return {Form1065) and all profits are reported by each
owner on their individual 1040 Form.
The
main advantage of the Limited Partnership is it has two types of owners.
The general partners have voting rights and control, while the limited partners
do not. This allows the general partners to control the distribution of profits,
even though they may have been taxed at the limited partner's tax bracket
A
business owner with children over the age of 14 can utilize his/her children's
tax brackets as limited partners and not lose control over the entity, even though
the children may own a majority.
One
disadvantage of the Limited Partnership could be the business owner's ability
to access money within the partnership for his or her own purposes.
Each
entity has both pros and cons. However taking advantage of all of the pros while
minimizing the cons should yield significant tax savings. By utilizing the self-employment
tax savings of the S-Corporation and the lower tax brackets available in the C-Corporation
and Limited Partnership, an owner can save up to 30% on their tax bill. If these
entities are put together appropriately with an LLC, it {the structure} can be
easy to manage.
Most
business owners could find ways to spend the additional 30 percent savings such
as reinvesting in the business, improving cash flow, and increasing employee benefits.
While most businesses may only use one entity, modifying the structure may be
more profitable.
(Reprinted
with kind permission of the Utah Business Magazine)
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