Posts Tagged ‘new business’

What type of entity should I choose? Part 6

Our Firm previously posted a five part series discussing the advantages and disadvantages for the type of entity you choose for your business: Sole proprietor, Partnership, Limited Liability Company, S Corporation, and C Corporation. In a business group I attend, members of the group wanted to see an example of the potential tax savings between the various types of entities. Below is a comparative analysis of an Insurance Agent as a sole proprietor, S-Corp, or C- Corp to illustrate how a taxpayer can reduce FICA tax. A taxpayer can reduce the FICA tax vs. a Sole Proprietor by paying low officer wages reducing FICA tax (in this example) by $17,854. In a C-Corp, the income does not pass-through to the shareholder; therefore, the income would be taxed at the entity level and individual level if the Company pays dividends. The S-Corp appears to have the smallest potential liability of the three, but taxpayers should be aware of the additional compliance costs such as: annual meetings, entity tax return, annual state filings, and bookkeeping.

Sample Insurance Agent
2010 Tax Rate
         
     Sole Proprietor   S-Corp  C-Corp
 Business Income:        
 Commissions $  425,000  425,000   425,000
 Wages     (50,000) (50,000)
 Business Expenses   (110,000) (110,000) (110,000)
 CA Corp. Tax Deduction     (3,860) (22,749)
 Payroll Tax Deduction     (3,825) (3,825)
 State Payroll Tax Deduction     (838) (838)
 Net Taxable Income- Business    315,500 256,477 237,588
 Business Taxes:         
 SS/FICA INC W/H   21,679 3,825 3,825
 Federal Corporate Tax       75,909
 CA (S and C) Corp Tax     3,905 23,014
 Total: Business SS and Corp. Taxes   21,679 7,730 102,748
 Total: Individual FED and STATE Taxes   95,503 100,666 8,497
 Total Taxes Paid  $ 117,182 108,396 111,245
 Assumptions for this Illustration:        
 FICA Tax – ER (7.65%) and EE (7.65%)        
         
 Corporate Tax Rate – 15% to 39%        
 CA S-Corp Tax Rate – 1.5%        
 CA Corporate Tax Rate – 8.84%        
 Individual FED Marginal Tax Rate  – 15% and 33%        
 Individual CA Marginal Tax Rate – 4.3% and 9.6%        
         
         

 Please note, these are simplified illustrations and when preparing actual tax Forms (1120, 1120S, and 1040) there are potential complex transactions involving basis, distributions, alternative minimum tax, etc. Please see your tax professional when considering your personal situation.

Opportunities and Pitfalls in Organizing a New Business

Recently we received a call from an attorney incorporating a start up. 

His question was simple enough:  “I need to know how to quantify beginning capital for this corporation I formed on December 31, 2009; there is cash and IP (Intellectual Property) involved.”

Upon learning the facts, we determined the people that formed this corporation were about to step into a taxable event of over $3 million!  We were glad we got the call before it was too late!

The lesson to be learned here is that it is always a good idea to get expert advice when forming a new company.  It can be very complicated!  Believe it or not one of the first things to consider is the ultimate exit strategy.  Frequently exit strategy drives the decision regarding both the form and tax options of the new entity in formation.

For small businesses engaged in a “trade or business” there is an exit strategy benefit worth planning for: 

Shareholders of Corporations formed after 2/17/09 and before 1/1/2011 get a 75% exclusion from capital gains up to $10 million.  Previously this was 50% and at that rate it saved a ton of tax!  The corporation must be a C corp. from inception.  If you want to use this strategy but still pass the initial losses to the founders, start with an LLC and form the corporation when you get traction and investors.  If you hold the stock for 5 years before sale, you get the exclusion.  There are details and  limitations that are beyond this discussion.

When forming an entity with sweat equity and money, “sweaters“  beware !

If the money partner puts in property (and/or money) of $1 million and the “sweaters” put in labor for 50% equity, they realize taxable earned income of $1 million upon receipt of the stock.   Usually the money partners want “know how” or other  I.P.  If this situation fits, turn your “sweat” into “property”  before you receive stock.  You could save a fortune!   Written business plans, patents, laptops….all property!  Work for your equity……. Taxable! 

If the money partner puts in $1 million for 50% and the “sweaters” put in labor for 50%, they realize income of $1million upon receipt of the stock.  This can be devastating to starving start ups.

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