|
Should I Incorporate?
A
few years after I first started preparing income taxes for the
public, I received the letter every person on the planet dreads.
It was from the IRS, informing me that we were going to be
audited. It was a simple thing, really...I had inadvertently failed
to report income from an account I had completely forgotten about!
My record keeping left a lot to be desired in those days, before I
realized the importance of keeping every receipt and cancelled check
we had ever written! My bank statement for the account had been
lost during a move. I didn't think much about it until the tax man
showed up at my door. I was very fortunate to be audited by a
wonderful man who took the time to teach me as we went along. It
was an incredible learning experience and one for which I shall be
eternally grateful. I learned that (with the exception of failing
to report income reported to the IRS on federal forms by employers,
banks and the like) most audits are caused by informers. Angry
ex-employees, rotten neighbors, jilted lovers and former friends
call or write the IRS and tell them to investigate your returns
because they know you are cheating on your taxes! Most corporate
returns are never audited. For more detailed information about
Corporations/Partnerships, contact your accountant, attorney or
local IRS office.
Advantages of Incorporating
A. Owners of sole
proprietorships reported on Schedule C, and many partnerships
are subject to unlimited personal liability for any type of business
debt. Creditors can hold the business owners personally liable for
debts. Creditors may be able to seize the proprietor's or partner's
home and other personal assets. Shareholders in
corporations are normally only liable for the money they put in
the business.
B. Sole Proprietorships list the business owner. Information on
members of a partnership are normally a matter of public record.
Involvement in any type of corporation can be anonymous. That's a
plus.
C. A corporation has the most enduring legal business structure
as it has a life of its own, and may continue on regardless of what
may happen to individuals within the corporate structure, such as
shareholders or officers. When a "sole proprietor" or "partner"
dies, the business normally ends or becomes entangled in legal
matters. Shareholders can transfer their ownership in the
corporation by selling their stock, without disrupting the business,
if it's large enough.
D. Corporations can generally raise capital easier with a
corporation, using their equity in corporate assets.
E. Corporations offer tax-deductible health and life insurance
benefits and can provide an increased tax shelter for retirement
plan. **There are other advantages that I could list, but they
pertain to corporations that have a lot of shareholders and stock to
sell. This isn't really pertinent to our discussion here.
Back To Top
Disadvantages of
Incorporation.
Starting and maintaining a corporation means more costs for
attorneys fees and/or CPA's fees, paperwork and record-keeping. There may not
be enough income to take advantage of all the tax benefits if the
"profit" is not very significant.
Back To Top
Types of Corporations.
Any individual or group of
individuals who operate a business may incorporate.
Back To Top
The "General" Corporation
A "general" corporation is owned
by an unlimited number of shareholders who are all protected from
creditors if the company goes into debt. The shareholder's personal
liability is usually limited to their actual investment in the
corporation. Shareholders personal assets are protected from all
business liability and debt. The corporation is subject to all
state and federal rules and regulations. Most horse and livestock
operations are not big enough to necessitate an "unlimited" number
of shareholders, so this is not a realistic structure for what we're
discussing.
Back To Top
The Close Corporation
Close corporations are
limited to 30 to 50 shareholders and have statutes that require
directors to offer their shares to existing stockholders before
selling to prospective shareholders in most states where they are
recognized. This type of corporation works wonderfully for stallion
syndications that , incorporate a group of individuals who own the
corporation with some members being actively involved in the
management of the corporation, and other members who are only
involved on a limited or indirect level, with respect to the actual
breeding of their personal mares.
Back To Top
The "S" Corporation
When a general, close or
professional corporation makes a profit, it pays a federal
corporate income tax on that profit, and if the corporation also
declares a "dividend", each shareholder must report this on their
personal tax return, as dividend income and pay more taxes. "S"
Corporations avoid this "double taxation" (once at the corporate
level and again at the personal level) because all income or loss is
reported only once on the shareholders personal tax return. All "S"
Corporation shareholders are exempt from personal liability for
business debt. The IRS grants a special "S" tax designation to
an existing corporation. Small business owners apply for
this special designation because it combines many of the
advantages of a sole proprietorship, partnership and corporate
business structure. "S" Corporations have the same basic advantages
and disadvantages of a general or close corporation with the added
benefit of the special "one time" tax provisions. To elect S
Corporation status, your corporation must meet specific guidelines.
A few of these guidelines are noted below:
- An S Corporation
may have up to 75 shareholders.
- S Corporation ownership
is limited to individuals, estates, and certain trusts. Under new
laws, stock of an S Corporation may also be held by a new
"electing small business trust." All beneficiaries of the trust
must be individuals or estates. Charitable organizations may also
hold limited interests. Interests in the trust must not be
purchased, but be acquired by gift or a bequest. Each potential
current beneficiary of the trust is counted towards the 75
shareholder limit on S Corporation shareholders.
- S Corporations are now
allowed to own 80 percent or more of the stock of a regular C
corporation, which may elect to file a consolidated return with
other affiliated regular C corporations. The S Corporation itself
may not join in that election. In addition, an S Corporation is
now allowed to own a "qualified subchapter S subsidiary." The
parent S Corporation must own 100 percent of the subsidiary's
stock.
- Qualified retirement
plans or Section 501(c)(3) charitable organizations may be
shareholders in S Corporations.
- Nonresident aliens
cannot be shareholders.
- All S Corporations must
have shareholders who are citizens or residents of the United
States.
- S Corporations may only
issue one class of stock.
- No more than 25 percent
of the gross corporate income may be derived from passive income.
- An S Corporation can
generally provide employee benefits and deferred compensation
plans.
- S Corporations eliminate the problems faced by
standard corporations whose shareholder-employees might be subject
to IRS claims of excessive compensation.
- Not all general business
corporations are eligible for S Corporation status. These include:
- A financial institution
that is a bank;
- An insurance company
taxed under Subchapter L;
- A Domestic International Sales Corporation (DISC);
or
- Certain affiliated
groups of corporations.
Back To Top
Limited Liability Company
(LLC)
LLCs have long been a
traditional form of business structure in Europe and Latin America.
LLCs were first introduced in the United States by the state of
Wyoming in 1977 and authorized for pass- through taxation (similar
to partnerships and S Corporations) by the IRS in 1988. With the
recent inclusion of Hawaii, all 50 states and Washington, D.C. have
now adopted some form of LLC legislation for both domestic and
foreign (out of state) limited liability companies. Many business
professionals believe LLCs present a superior alternative to
corporations and partnerships because LLCs combine many of the
advantages of both. With an LLC, the owners can have the corporate
liability protection for their personal assets from business debt as
well as the tax advantages of partnerships or S Corporations. It is
similar to an S Corporation without the IRS' restrictions.
Advantages
- Protection of personal assets
from business debt.
- If an LLC has satisfied
IRS requirements, it can be treated as a partnership for federal
tax purposes.
- Profits/losses pass
through to personal income tax returns of the owner.
- LLCs do not have the
ownership restrictions of S Corporations.
- Corporations making
them ideal business structures for foreign investors.
Disadvantages
LLCs often have a limited
life (not to exceed 30 years in many states) Some states require at
least 2 members to form an LLC, and LLCs are not corporations and
therefore do not have stock -- and the benefits of stock ownership
and sales. As with the S Corporation listing, these lists are not
inclusive. For more detailed information, please be sure to speak
with a qualified legal and/or financial advisor.
Back To Top |
