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How
should we do business?
Choices
of legal entity for Arizona companies
Click
on the entity you wish to review:
Sole
Proprietorship
Regular
or "C" Corporation
S
Corporation
General
Partnership
Limited
Liability Company and Limited Liability Partnership
Professional
Corporation
Sole
Proprietorship.
Simple form of
organization. No extra tax return needed; just schedules in Form 1040.
No extra organization or corporate minutes. No annual corporate meeting
or filing.
Liability:
No limited liability;
owner fully liable; purchase of business liability insurance is a very
important consideration
Taxes:
Schedule C, Form 1040
Fringe
Benefits: All taxes paid by individuals Medical costs not
deductible as a business expense Easier to get home office deduction
Full FICA (self employment tax) paid Can deduct 100% of
owners health insurance (effective in 2003) Can put children
under 18 on payroll to save tax; they do not pay FICA tax and may not
pay income tax
Ownership:
One individual owner
Tax Year-End:
Must be calendar year-end
Special
Advantages: Simplicity; may not need double-entry bookkeeping
("shoe box" accounting) No extra tax return needed
Legal, accounting and administrative costs lower Can later shift to
other forms of business with relative ease Easier to get out of
business
Major
Disadvantages: Full FICA tax paid (sole proprietors are often
shocked at the amount of tax they pay (federal + FICA + state tax)
Personal liability for business lawsuits and debt Cannot split
income between years or family members Probably higher audit risk
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Regular
or "C" Corporation.
The regular
corporation requires a separate corporate entity with separate corporate
tax returns, plus annual reporting to the Arizona Corporation
Commission.
Liability:
Shareholder liability is limited to money invested (exception:
liability is never limited for ones own professional malpractice)
Taxes:
Initial tax rates are very low (15% on first $50,000) Double tax
danger: without proper planning, share-holders may pay tax once in the
corporation, then again as they take money out
Fringe
Benefits: Shareholders medical expenses can be 100% deductible
business expense (not true for any other form of business) Real
estate generally should not be held in corporation Can plan to shift
income Possible exclusion of 50% of long term capital gains for sale
of small business stock issued after 4-10-93 Cafeteria plans for
medical expenses and day care available Can use employee stock
ownership plans for deduction Meals and lodging for benefit of
employer is not income Life insurance benefits up to $50,000 policy
can be tax free
Ownership:
At least one shareholder No maximum number of shareholders
Tax Year-End:
Any Tax Year-End available
Special
Advantages: Good way to build up capital in business at low tax
rates Good way to split income between personal and business
Easier to plan between tax years if non calendar year-end Can pass
shares of stock to family members for estate planning Less problem
with passive loss rules
Major
Disadvantages: Should have annual minutes and board of directors
meeting Alternative minimum tax (AMT) in some situations
Accumulated earnings tax (39.6% of monies accumulated that exceed
reasonable needs of business) Double taxation; if care is not taken,
earnings can be taxed once in the corporation and then again as
shareholders draw out profit Asset sale of business is complicated
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"S"
Corporation.
S-corps (formerly
known as "Subchapter S corporations") have been around since
the 1950s. A regular corporation can become an S by filing a special
election (Form 2553). Separate corporate tax returns and annual
reporting to the Arizona Corporation Commission are required.
Liability:
Shareholder liability is limited to money invested Liability is
never limited for ones own professional malpractice
Taxes:
Generally all taxes are paid by shareholders All losses and
income flow to individual shareholders No FICA tax paid by
shareholders on corporate net income Shareholders can only deduct
60% of their health insurance (70% in 2002, 100% in 2003)
Fringe
Benefits: No double taxation on earnings Business losses passed
through to individuals for tax benefits, but they are limited to
shareholders basis in stock and direct loans to S-corp
Ownership:
One to 75 shareholders Real estate should not be held in
S-corporations
Tax Year-End:
Generally must be calendar year-end (unless business purpose
established to IRS, or can have September, October or November year-end
with possible extra tax to pay)
Special
Advantages: Ability to avoid some FICA tax (shareholders must still
take reasonable salary) Debt to acquire S-corp stock is deductible
business interest (as opposed to investment interest) No double
taxation on earnings No accumulated earnings tax or personal
holdings company tax No alternative minimum tax
Major
Disadvantages: If shareholder owns more than 5% of stock, he cannot
borrow from pension plan Partnerships and corporations cannot be
shareholders; only U.S. citizens or residents and some trusts Must
be a U.S. corporation with one class of stock Cannot borrow money
from pension plan Dissatisfied shareholder can terminate S election
by transferring stock to C-corporation Unlike partnerships, debts of
S-corps do not cause basis for loss
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General
Partnership.
Two or more partners
required. Partners can be individuals, corporations, trusts and/or other
partnerships. Very flexible form of doing business. There must be at
least one general partner. Separate partnership tax returns are
required. Business owners considering a partnership should look closely
at an LLC or LLP as an alternative entity. Existing partnerships should
consider converting to an LLC or LLP.
Liability:
No limit on liability for general partners
Taxes:
All income and expenses flow through to the partners, usually based
on their ownership percentage Good way to hold real estate with
multiple owners Can only deduct 60% of partners health insurance
(70% in 2002, 100% in 2003)
Fringe
Benefits: Easy to form; written agreement recommended but not
required Can easily allocate income and deductions among partners
Business losses passed through to partners for tax benefits
Ownership:
One or more partners Some can be limited partners with liability
no greater than their investment
Tax Year-End:
Generally must be calendar year-end, unless business purpose
established to IRS, or can have September, October or November year-end
with possible extra tax to pay
Special
Advantages: Annual minutes not required Written agreement
technically not required Family limited partnerships good vehicle
for estate planning No double tax on earnings No accumulated
earnings tax or personal holding company tax No alternative minimum
tax (AMT) Good way to hold real estate Debts of partnership give
tax basis to general partners
Major
Disadvantages: General partners can be fully liable for all debt and
all actions incurred by partnership or partners
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Limited
Liability Company and Partnership.
The LLC is a
relatively new form of doing business. Also can be a PLLC (Professional
Limited Liability Company) or LLP (Limited Liability Partnership), which
are basically the same as an LLC.
Liability:
Liability of owner limited to investment; this is a major advantage
over partnership Liability is never limited for ones own
professional malpractice
Taxes:
All income and expenses flow through to members (partners) Good way
to hold real estate with multiple owners Can deduct 100% of
owners health insurance, starting in 2003) Can easily allocate
income and deductions between partners
Fringe
Benefits: One-member LLC can file Schedule C Unlike
corporations, no annual report to Arizona Corporation Commission
Ownership:
One or more owners (properly known as "members")
Tax Year-End:
Generally must be calendar year-end, unless business purpose
established to IRS, or can have September, October or November year-end
with possible extra tax to pay
Special
Advantages: Owners can participate in management without risking
personal liability No requirement for annual minutes Family
limited partnerships good vehicle for estate planning No double tax
on earnings No accumulated earnings tax or personal holding company
tax No alternative minimum tax (AMT) Some members may not be
subject to FICA tax Good way to hold real estate
Potential
Disadvantages: LLCs laws not uniform from state to state Because
LLCs are relatively new, much of the tax law has not been tested
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Professional
Corporation. Doctors,
lawyers, accountants and other non-sales professionals who are
incorporated as a regular corporation usually end up being classed as
PCs often referred to as "personal service corporations"
in tax parlance.
Liability:
Shareholder liability is limited Liability is never limited for
ones own professional malpractice
Taxes:
Taxes are always at high corporate tax rate of 35% Double tax danger
without proper planning, owners may pay tax once in the Corporation,
then again as shareholder takes money out
Fringe
Benefits: Shareholders medical expenses can be 100% deductible
business expense (not true for any other form of business) Cafeteria
plans for medical expenses and day care available Meals and lodging
for benefit of employer is not income Life insurance benefits up to
$50,000 policy can be tax free
Ownership:
One or more shareholders
Tax Year-End:
Generally calendar year-end required
Special
Advantages: Fringe benefits Limited liability
Major
Disadvantages: Should distribute income out every year Generally
should have calendar year High tax bracket on net income (35%)
Real estate should not be held in a corporation
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