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You are taxed at the partner level
which means that certain deductions and income flows thru
to you and is subject to Self-Employment tax (
these deductions may or may not be deductible). When any one partner leaves or dies the
partnership automatically dissolves. So there is no perpetual
existence. Since there is no perpetual existence there is
also no transferability. If one partner wants to sell his
share the whole business technically dissolves.
3)Limited Liability Partnership(LLP) –
like a partnership but with limited liability. The benefits
of this type entity are limited to very few, complex situations
and are really beyond the scope of this article. Trust me
when I say that 95% of you don’t want or need this type
of business form.
4)
Limited Liability Corporation (LLC) – this is the
one the attorneys love…because it is new. In some instances
it is very useful since members (not Shareholders – there
are no shares of stock) can be foreigners/trusts and other
entities that are otherwise not allowed to be shareholders
in an “S” corp. At first, it appears to
have the best of all
types…limited liability, have
as many members as you like, ease of transferability, and members can participate in management
decisions without losing personal liability protection.
BUT, the short comings are too high on the scale even if
they are few :
a)
First, and most importantly, is that there is not
much case law on LLC’s. This is
an extremely important issue since you are presumed to owe
whatever the Tax commissioner has assessed you in U.S. Tax
Court. There is no presumption of innocence. This being
the case remember courts must follow precedence when making decisions.
If there is no precedence in your favor YOU LOSE!
b)
Since most tax law is written with specific language of
“shareholders” when defining different consequences to different
transactions we cannot be sure if a member has the same
meaning. Therefore certain transactions regarding transfer
of assets and Capital Gains are not clearly defined or available
to “members”. I tell my clients who want LLC to wait and
see.
5)
Corporation (C) – This is a good solid form of business.
There is much case law, it has ease of transferability,
it is a separate entity that has
limited liability (unless you pierce the corporate veil)
and exists into perpetuity. The Major
problem of this entity is:
a)
Double taxation – the corporation is taxed on
any/all profit, and you the owner, are taxed on your wages
and dividends. Thus potential taxation on two levels of
the same dollars earned (This is particularly true if you
don’t take any wages the first few years in business). You
can declare dividends, but dividends are not deductible
by the corporation for income tax purposes, and are includable
in your personal tax return. Some
advantages of a
“C” corp.
is that most Health Care and Cafeteria Plans are fully deductible,
as are different retirement plans and other
employee benefits plans. Since all income and all deductions
stay on the corporate (they don’t flow –thru like we have
with other types) return, IRS audits generally
begin and end with that entity.
6)
Corporation (S)
– This is probably the only real Loop Hole left
in Tax law. “S” corps. Have
many of the benefits of
“ C” corps
such as limited liability, ease of transferability,
perpetual existence, etc. It is formed the same way as a Standard
“C” corp. except you make a timely election with the Federal government on
form 2553. Once accepted by the IRS, you are now an “S”
corp .The best part of “S” corps is that any profit or
loss that is computed is passed thru to the Shareholders
and is NOT subject to Self- Employment tax. Therefore you
can actually save on payroll taxes by properly planning
and dividing your next years distributions
into Wages and Previously Taxed Income distributions and
thereby have less payroll and related taxes. Also, by having
an employee retirement plan like an SEP or Simple IRA you
can fund it with “S” corp profits take the deduction on the corporate level and
put the CASH into your account (i.e. IRA) The only downside to “S” corps is that
there are a limited number (75) , and type (can’t have a
foreigner), of shareholders. Most of us don’t have to worry
about that anyway. There are some other flow
thru items that may not be advantageous to you particularly,
but over-all this CPA believes “S” corps are still one of
the best choices. This
information should be enough to get your head churning (or
spinning). Think about what might be best for you and make an appointment with your CPA. Also
remember that I have only touched the surface on each entity’s
pros and cons. Your situation might be such that one of
the other entities are better suited to your needs. In my next article I will get into more
details about deductions, who, how, where and when to take
them. Until then… Happy Luthiery!
David
S Bland, Certified Public Accountant, Luthier |
