Tag: small business organization

Business Structure Tax Issues-Part 3 LLCs

This is the third and last installment in a series of articles which addresses the tax implications of various business structures. The business structure that an entrepreneur chooses for his or her business has both legal and tax implications. This installment will discuss the tax implications of a Limited Liability Company.

Your business structure can impact your tax liability.
Your business structure can impact your tax liability.

This series of articles has already discussed C Corporations and S Corporations. Both of these forms of business structure had the advantage of limited liability. But they both have disadvantages. The C Corporation has the disadvantage of double taxation, while the S Corporation has a lack of flexibility (for example, limits on the type and number of shareholders, etc.).

The Limited Liability Company(LLC) arose as an alternative form of business structure. LLCs are a relatively new business structure, arising from state law less than forty years ago. States viewed the LLC form of business as a way to attract companies to their State with a more flexible business structure. In 1988, after the IRS ruled that LLCs would be treated as partnerships for tax purposes, the number of States that created statutes allowing the LLC form of business grew exponentially (http://law.jrank.org/pages/8277/Limited-Liability-Company-History.html [accessed 12/2/2016]).

As a general rule, LLCs allow limited liability[1], pass through taxation to the individual owners, along with flexibility.

For example, as discussed in the Part 2-S Corporations, in the S Corporation structure, the owners must allocate profits and losses on a pro rata basis, dependent upon stock ownership on each day of the tax year. In LLCs, the partnership agreement governs the split of profits and losses, and special allocations are permitted. This means that the profits and losses may be allocated differently than on a pro rata basis which allows greater flexibility.

If the LLC has a single owner, the LLC will be taxed like a sole-proprietorship.[2] The single owner can include the revenue and expenses on their individual income tax return (Schedule C, Schedule E or Schedule F) (https://www.irs.gov/pub/irs-pdf/p3402.pdf [accessed 12/2/2016]). If the LLC has multiple owners, the LLC is treated as a partnership and files a Form 1065-U.S. Return of Partnership Income (https://www.irs.gov/pub/irs-pdf/p3402.pdf [accessed 12/2/2016]).[3]

The LLC seems like the best of all worlds, right? There are some disadvantages to an LLC. Since the LLC is considered either an entity disregarded as separate from its owner (one-member LLC) or a partnership (multi-member LLC), the net income to the owners is considered self-employment income and subject to self-employment tax.

Plus, remember that a multi-owner LLC is treated as a partnership for tax purposes. Several years ago, I heard a presenter at a tax conference state that partnership tax law is the most complex tax law in the U.S. Internal Revenue Code. (My response to that is that this presenter obviously had never been exposed to the U.S. tax law related to foreign transactions!).

Even so, partnership tax law, especially concerning partnership acquisitions and dissolutions, is very complex. This is something to keep in mind when choosing the LLC form of business. LLC’s may give you a lot of flexibility, but be sure you receive good tax and legal advice.

If you have any U.S. small business tax questions or need some help with your taxes, feel free to contact CPA WorldTax at taxinfo@cpaworldtaxllc.com or 888-512-4860.

[1] If you have questions on legal implications, please discuss with your attorney.

[2] If the LLC is owned by a husband and wife, the reporting options vary. Be sure to consult a qualified tax advisor.

(https://www.irs.gov/businesses/small-businesses-self-employed/single-member-limited-liability-companies [accessed 12/2/2016]).

[3] Unless the owners elect the check-the-box regulations to be taxed as a corporation. Treas. Reg. Sec 301-7701-2 (https://www.law.cornell.edu/cfr/text/26/301.7701-2 [accessed 12/2/2016]).

 

Business Structure Tax Issues-Part 2 S Corporations

This is the second installment in a series of articles which addresses the tax implications of various business structures. The business structure that an entrepreneur chooses for his or her business has both legal and tax implications.[1] This installment will discuss the implications of an S Corporation.

People interconnected with depth of field on the concept of team.
Organizing your business obviously focuses on production and efficiency. It also has legal and tax implications.

As discussed in the first installment, C Corporations are legal entities separate from their owner (https://www.sba.gov/starting-business/choose-your-business-structure/corporation [accessed Nov. 4 2016]). The separate legal entity was a distinct advantage for business owners over an unincorporated business. But the disadvantage was that the C Corporation was subject to taxation both at the entity level and the shareholder level (double taxation).

In the 1950’s U.S. Congress decided to review Subchapter C of the Internal Review Code because they felt that C Corporations were too restrictive for small businesses. What resulted from this examination was Subchapter S of the Internal Revenue Code.

The purpose of Subchapter S was to allow small businesses to select a corporate business structure without being concerned about tax implications and to allow the income or losses from their business to be taxed at the shareholder level instead of at the corporate level (S. Rept. No. 1983, 85th Cong., 2d Sess., p. 87 (1958)).

An S Corporation is a “flow-through” entity for tax purposes. Like a partnership, all of the income and losses “flow-through” the S Corporation to the individual shareholders, retaining their character. For example, if the S Corporation sells stock at a long-term capital gain (LTCG), this LTCG flows through to the individual shareholders and retains it character so that it is taxed at LTCG rates to the shareholders.

The S Corporation would seem on first glance to solve the problems of the C Corporation. It is a separate legal entity, but there is only one level of taxation.

But do remember that an S Corporation is a construct of the U.S. Congress.[2] That means that it is an election that the shareholders need to make (with Form 2553-Election by a Small Business Corporation). That also means that most of the other corporate rules governing formation and dissolution, for example, are still governed by the C Corporation rules.

Further, there are several restrictions to the S Corporation which have made them a little more unappealing. Many of these rules have been loosened over the years, but there are still restrictions on the number of shareholders and type of shareholder which can own S Corporation stock.

One restriction concerns the allocation of profits and losses. A shareholder receives a pro rata share of each item of income or loss based upon their stock ownership on each day of the tax year (IRC 1366(a), Treas. Reg. 1-1366-1(a)). Another restriction is that the S Corporation can only have a single class of stock (IRC 1361(b)(1)(D)).

These restrictions mean that the shareholders cannot determine the allocation of income or loss items through an agreement or stock ownership. These rules decrease the flexibility of an S Corporation.

In the next installment, we will look at Limited Liability Companies (LLC) which is a business structure with generally less restrictions than an S Corporation.

If you have any U.S. small business tax questions or need some help with your taxes, feel free to contact CPA WorldTax at taxinfo@cpaworldtaxllc.com or 888-512-4860.

[1] If you have questions on legal implications, please discuss with your attorney.

[1] Be sure to check the tax laws of your individual State. State tax laws may not recognize the S election.