Corporation Overview
WHAT IS A CORPORATION
All corporations are created as a C-Corporation, with the legal status of a legal “person” formed separately from those who own and operate the corporation. They are, in effect, created of legal age, in any state that the owners choose (it will be only authorized to operate in the state of incorporation unless the corporation is specifically ‘licensed” to do business in another state (commonly called “foreign filing”). Although they obtain their own social security number (known as an employer identification number or EIN), they have no social security taxes to pay for themselves because they are not physical persons. They do have to file annual tax returns on IRS form 1120, even if they earn no money during the year.
As an “artificial person” the corporation’s debts and taxes are separate from its owners (shareholders) or its officers and directors, thereby offering the greatest personal liability protection of all business structures. And because the corporation continues to exist even after the death of a shareholder, it offers tremendous estate planning advantages as well. An interesting aside is that once a corporation is formed, it can live for hundreds of years, well out living its original creators. Just think of the estate planning possibilities.
FEDERAL & STATE Corporate taxes
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C-Corporation profits and losses will not be passed through to its owners like they are with Limited Liability Companies (LLCs) and “S”-Corporations, but rather they will be taxed separately on an 1120 IRS tax return.
C-Corporations pay their own taxes, usually at a lower rate than individual income tax rates. For example, the current tax rate for a C-Corporation is 15% of the first $50,000 of taxable “NET” income versus the individual (personal) rate of 28% of “GROSS” taxable income for the same $50,000. As income rises, the corporate rate continues to be lower than the personal tax rate. C-Corporations pay around 22.25% on the first $100,000 of its NET profits and less than 31% on the first $200,000 of NET profits. On the other hand, an individual can pay as much as 39% of $200,000 in GROSS taxable income. Here is the reality of what we are trying to explain:
Individuals receive income, pay taxes and then buy things (and pay bills) with whatever
“after-tax” money is left over (after taxes are taken out).
This taxability is based on the full gross amount of the individual’s income.
Conversely, “C” Corporations receive income, buy things (and pay bills) with “pre-tax” dollars and then pay taxes on any money that is left over.
This taxability is based on the NET amount of the C-Corporations income.
Business Losses:
A very BIG consideration in today’s economic insecurity is the potential for business losses. LLCs and “S”-Corporationsare allowed to deduct their business losses subject to a 25% restrictive passive loss rule. That means that 75% of your losses you MUST simply “EAT”. OUCH! However, should you be structured as a C-Corporation, you would be allowed to deduct 100% of all business losses.
Double Taxation:
The corporation pays it’s own taxes and the shareholders pay taxes on the dividends they receive. However, it is possible for smaller C-Corporations to avoid the double taxation problem all together through paying owners bonuses or contributing to retirement plans, which are both tax-deductible expenses. Earnings can also be retained for future growth and purchases. It would be a rare case in deed if a C-Corporation with earnings under 5 million dollars had to concern itself with “Double Taxation".
Tax planners continue to spread fear concerning the potential for double taxation with C- C-corps. Double taxation comes into play where after-tax earnings of a C-corp are distributed to shareholders as non-deductible dividends. This is rarely a problem with small corporations and/or non-publicly traded corporations because there are so many legitimate ways to pull money out of the C-corp in a manner that is deductible, and thus only taxed once. Some of these are:
l Compensation Plan
l Interest Payments
l Lease Payments
l Royalty Payments
l Contributions to Retirement Accounts
l Benefit Plans (including Life and Health Insurance)
Attack On the Rich: "Mean Testing" (penalizing the evil rich) is a growing trend in this country, and is most often measured by the AGI on your 1040. People over certain tax thresholds lose tax breaks and have to pay more taxes and penalties than others do. Income from an S-corp or LLC will just make things worse. Income on a C-corp will not be counted in most mean testing.SOLE PROPRIETORSHIP: A sole proprietorship is the least complicated business organization from a tax and operations perspective. This is why eighty percent of the businesses are sole proprietorships. A person can form a sole proprietorship with a simple business license. No further documentation is needed. In fact, if you are running your own business and haven’t formed a partnership, LLC or corporation, you have created, by default, a sole proprietorship even if you haven’t purchased a business license yet.
Sole proprietorships have definite advantages. They are easy and relatively inexpensive to set up. In a sole proprietorship, you, as the owner, have full control of your business decisions. You also face minimal legal requirements and restrictions while owning all of your business’s profits.
Unfortunately, there is no liability protection for sole proprietors. This means that you will be personally responsible for business debts and other liabilities such as lawsuits. It is also more difficult to raise money to expand a business that is a sole proprietorship since sole proprietorships are fragile entities that last only as long as their owners have the will and the ability to continue doing business.
There are also negative tax issues of sole proprietorships. All income your business generates must be reported as personal income, which is taxed at a higher rate. This is called “pass-through” taxation. When your business begins, this taxation may be beneficial because it is easier to prepare a Schedule C for your personal income taxes than to prepare a corporate tax return. However, the Schedule C form is one of the most audited because the IRS is suspicious of profitable sole proprietorships. Also, since you will not have an employer contributing to your Social Security and Medicare taxes, you will be required to pay self-employment taxes (15.3% of your first $94,000 of income).
By definition, a sole proprietorship has a single owner – you. As your business grows to the point where you need other owners, you will need to choose a different business structure.
ENTITY STRUCTURES THAT ARE NOT RECOMMENDED
General Partnership: The General Partnership essentially has one type of partner — an individual who has unlimited joint liability for partnership obligations. Partners in a General Partnership have unlimited personal liability and also have a mutual agency relationship between them, providing each with an equal ability to bind the partnership and to participate in its management.
Limited Partnership: A Limited Partnership is a partnership that differentiates the rights and obligations of its individual partners. The partnership itself is made up of two classes of partners, general partners and limited partners. The general partner in a Limited Partnership has the same unlimited personal liability for the partnership debts and torts as the partners in the General Partnership. The Limited Partner(s), however, generally, are only financially liable and then only to the extent of their agreed-upon capital contribution.
ENTITY STRUCTURES THAT ARE RECOMMENDED
LIMITED LIABILITY COMPANIES
What Is A Limited Liability Company (LLC)? A Limited Liability Company (LLC) is a hybrid between a corporation and a limited partnership. Members are afforded the limited liability of corporate shareholders and the pass through tax advantages of a partnership (or S-corp) without the restrictions imposed on limited partnerships and Subchapter S-corps. Management and ownership may be structured in any fashion as specified in the Operating Agreement, thereby allowing for total flexibility in income distribution. Management of the limited liability company is vested in its managers (called Managing Members). In addition, the Operating Agreement is not required to be publicly filed, maintaining confidentiality of the ownership structure.
The LLC must be organized with two or more members (NOTE: many states allow one person or a husband and wife to form an LLC, but the IRS WILL re-characterize the LLC as a proprietorship unless you have 2 or more members). Members may be any person or legal entity, domestic or foreign, which owns an interest in the company. Members have no liability for the debts, obligations or liabilities of the company to any third parties, whether any such debts, obligations or liabilities arise out of contract, tort or otherwise, solely by reason of being members of an LLC.
Advantages of Forming As An llc: LLC's can allocate any distribution of income, gain, deduction, or loss among its members. Under IRS guidelines, stockholders of corporations organized under Subchapter S are limited to distributing interest among its shareholders in proportion to their stock holdings. The entity may have any number of members, unlike a sub S-corp that is restricted to a maximum of 100 investors.
In addition, all corporations, partnerships, certain kinds of trusts, and non-resident alien individuals are restricted from being shareholders of a sub S-corp. On the other hand, LLC's are not subject to these restrictions. LLC operating costs are inherently lower than those of a sub S-corp. Whereas members of the Limited Partnership may not remove a general partner, an LLC is not required to declare a general partner. Managers designated by the members of an LLC may be subject to removal at any time by its members if desired.
Losses and Profits: An LLC is more desirable and flexible than an S-corp because pass-through losses under an LLC can be allocated separately to members. If the LLC is expected to have significant losses the losses will be passed through to the members and deducted against their personal 1040 income. Likewise for any profits. The trick is to have nothing left over at the end of the year except losses.
Tax Advantages: An LLC legally separates the business from its owners (like a corporation), yet it is treated as a partnership for tax purposes. In this case, the LLC doesn’t pay any tax itself – the income is passed through to the members as it is with partnerships and S-corps. The tax rules governing partnerships are more flexible, allowing for better tax planning than they are for S-corps. It is possible to "zero out" the company’s income every year with deductible payments that benefit you. These payments can include salary for the LLC’s managing member, benefits, lease payments for assets owned by the LLC and interest on loans. Notwithstanding the forgoing, members of an LLC can’t deduct retirement plan contributions nor can they form a pension plan or health/life insurance.
WHY NEVADA?
Nevada has aggressively worked to protect the rights of small corporations.
Some of the more noteworthy reasons for Nevada’s popularity are:
No State Taxes: Pro-business Nevada, unlike almost every other state in this country, has taken a stand! NEVADA does not tax the income of its corporations or its citizens.
Financial Privacy: Nevada has developed a corporate structure unlike that of any other state. Nevada statutes allow investors and owners of Nevada corporations to remain private. Most states in this country require that you publicly file the name and address of a corporation's directors, officers, and stockholders. Nevada, in an attempt to create a private corporate environment, requires only the name of the corporation's officers and directors, and specifically excludes vice-presidents and stockholders.
Asset Protection Nevada Style: Almost every state in the United States has adopted corporate statues that limit the liability of officers, directors and stockholders. Nevada has very specifically defined in its statutes that the ONLY way to “get to” the assets of the officers, directors and stockholders of a Nevada C-Corporation is where fraud has been perpetrated. This means that the corporation itself can be sued, file bankruptcy, or be involved in other unfortunate activities and still not jeopardize the personal assets of its representatives.
Nevada is one of only 13 states in America with protection like this. Of those 13, Nevada stands alone in protecting its business owners from lawsuits.
A Nevada Corporation Can Be Organized With Little Or No Capital: While most states require that a corporation have at least $1,000 in “paid-in” capital (cash/assets) Nevada has no such requirement. You can incorporate in Nevada for no more than the cost of incorporation.
To know what business structure best suits your need, send your inquiries to info@signetgroup.us.
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