Ch2 S4 Characteristics Of Business Forms

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sole proprietorship

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Does not require legal forms to start, or fees to create or maintain. No seperate tax forms. Taxable income is reported on 1040 sched C. The sole proprietorship are one in the same entity, so it does not matter if one deposits a check into personal account or in the business account.

-Disadvantage- The owner has unlimited personal liability for the liability of the sole propietorship. The business dies with the owner.

-Tax characteristics- Income is subject to self employment tax. Can't deduct premium payments for life or disability ins, but can deduct 100% of health ins premiums and LTC premiums if not eligible to participate in an eployer subsidized health plan

-Sale of business- any gains on inventory is treated as OI. Capital assets such as land will generate a CG or CL. If sale of the business is > than MV of assets, then gain is treated as goodwill, which is a capital asset, or CG.

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rules related to the greater-than-2% shareholder in an S

corporation

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the plan providing health insurance for the

taxpayer must be established by the S corporation. The S corp makes the premium payments, or the >than 2% shareholder makes premium payments and is reimbursed by s-corp. In both situations the premium payment is included in w-2 income, but not subject to FICA

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partnerships

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Do not need to obtain state approval, and are free from annual legal reporting requirements

Taxation

1.conduit taxation- income, deductions, and tax credits of the partnership pass thru to the individual partners tax return.

2. income is taxable regardless if partner has received it

disadvantage: unlimited liability, lack of continuity in the life of the partnership(partnership is auto dissolved at the death of one partner), management deadlock,

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three exceptions to the general rule that no income will be recognized on the liquidation of a partnership.

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All three exceptions involve the distribution

of Section 751 assets, or “hot assets.” The so-called hot assets are unrealized

receivables, appreciated inventory, and recapture on cost recovery property. All taxable as OI.

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LPs are generally used in 3 situations

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First, limited

partnerships are appropriate for the pass-through of losses from tax-advantaged

investments. Second, limited partnerships are well suited for investors who wish

to invest in a business, but who want to protect the rest of their financial

resources from a potential business failure. Finally, a limited partnership offers

the entrepreneur the advantage of locking any financial partners out of the

management of the venture.

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LP disadvantages

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it requires a great

deal more formality than the regular or general partnership, and it necessitates a

written partnership agreement.

states require that official

notice be given to the public that the business is a limited partnership and that the

creditors may not look to the limited partners to satisfy any business defaults.

Annual reports are often required, and the limited partnership form requires

updating information on file with the state every time the partnership agreement

or membership changes.

limited partner may lose the limited liability

status if the partnership fails to file required certificates or files a false certificate

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C Corp nontax advantages

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1.limited personal liability of owners.shareholders liabilities is limited to their capital contribution.

2.perpetual life

3.management advantages

4.capital is raised easily

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C Corp nontax disadvantages

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1.significant time must be spent on formalities

2.Lots of paperwork

3.More expensve to run

4.less flexible business form

5.majority shareholders can opress the minority

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C Corp tax advantages

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1.can create a new taxpayer with which income can be split.

2.can retain earnings at lower brackets

3.incorporate tax free-

one or more persons must transfer cash or property to the corporation solely in exchange for that corporation’s stock

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ordinary

loss treatment on

Section 1244 stock (c-corp)

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stock must be held by original owner and must have been issued by a domestic corp.

Section 1244

losses are deductible up to $50,000 per year against any other sources of income

and up to $100,000 per year on a joint return.

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C Corp tax disadvantages

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Double taxation essentially refers to the taxation of the income at the

corporate level and the subsequent taxation of dividend distributions at the

individual shareholder’s level

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Personal services corporations,c corp tax disadvantage

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all taxable income of “qualified personal service corporations” (PSCs) at

the highest corporate tax rate of 35%.

This provision encourages employee-owners

of PSCs to take more salary out of the corporation.

Most corporations are exempt from the

accumulated earnings tax for the first $250,000 retained. This limit is only

$150,000 for corporations that provide personal services, such as services in the

areas of medicine, law, engineering, architecture, accounting, actuarial services,

arts, and consulting.

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Personal Holding Companies c corp tax disadvantage

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Personal holding company income generally consists of income from annuities,

interest, dividends, rents, and royalties

.

purpose of this provision is to force nearly all personal

holding company income to be distributed to the individual shareholders so that

the income cannot be accumulated at corporate rates

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exclusion of gain from small business stock

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Must be a C xorp and must have < than $50mill in assets when stock was issued. If stock was issued after 2013, then only 50% of gain is excludable. Amount that is not excludable is subject to 28% cg tax

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Sale of C Corp

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Sell as a stock--is a capital transaction either generating a CG or CL. Double taxation is a result.

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S corporations

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Pay no fed taxes, instead the items of income, loss, deduction or credit flow thru to individual shareholders to be reported on their respective returns; just like a partnership, but w/ limited liability and w/out double taxation of C Corp

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Requirements to be an S corp

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1. Must be a domestic corporation

2. No more than a 100 shareholders. All members of a family may elect to be 1 shareholder.

3.Shareholders must be a citizen or resident of the US

4.Can only have 1 class of stock

5.All shareholders must consent to the election of class S

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Termination of an S corp

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1.majority of shareholders must vote for termination

2.involuntary termination- more shareholders than allowed, ineligible shareholder, etc. Is effective as of the date of the violation, not retroactive to first day of tax year.

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Sting tax

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Tax on passive investment income earned by an s corp. To be subject the s corps must have accumulated earnings and profits as a c corps from prior periods, and more than 25% of the s corps gross receipts must be from passive investment income.

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s corps advantages of partnerships and LPs

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1.shareholders have the right to participate in management.

2.shareholders don't have to worry about their limited liability status being jeopardized by the failure of the partnership to file the required certificate

3.stock is freely transferable. Subject to GP approval inpartnerships.

4.income from s-orp is not subject to self-employment tax

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Disadvantages of an s corp

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1. Not allowed to include debt in the basis of stock. Only allowed to count debt created by a direct loan from the shareholder to the corporation.

2. Fringe benefits for >than2% shareholders are deductible by the S corp but taxable to the shareholder

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3 taxes for which an s corp may be liable

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1.built-in gains tax; applies when the s corp disposes of an asset with appreciation

2.LIFO recapture tax: if a c corp used the LIFO method of inventory valuation for its last year before making an s corps election, it must include, in income, the amount of excess found when comparing the inventories value under FIFO with the LIFO value

3.net passive income

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LLC

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A statutory entity that must be formed under specific state law

1. Limited liability to all owners, or members

2.perpetual life

3.prohibiton against the transfer of management or membership rights without the majority approval

4.deferral to the LLC operating agreement for purposed of determining the LLCs management structure

If there is 1 owner, the owner files a shed C and is responsible for the self employment tax

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LLP

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Basically a GP with at least a partial liability protection for the partners. Based upon amendment to a states partnership statues, as opposed to a separate statutory agreement

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Domestic production activities deduction

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A result of the American Jobs Creation Act of 2004--50% of the w-2 wages paid by the employer

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Deduction for energy efficient commercial buildings

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$1.80 per building sq ft

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Tax credit for contractors building new energy efficient homes

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$1,000-$2,000 credit for each qualified new energy efficient home the build