What is the Best Legal Structure to Cut Taxes and Reduce Liability - S Corporation, C
Corporation or a Limited Liability Company?

Now, Explore some real options!
This is not the fluff that you hear elsewhere!

For someone to say that one structure will work best for all situations doesn’t make any sense. The most favorable choice depends on many factors-the number of owners, the type of business, whether or not it will be profitable right away, what type of income will it receive and how all this blends in with your current situation.

How will Your LLC Be Taxed? You Have Six Options…
And An 83% Chance of Selecting The Wrong One!

Let’s examine the options:

The first basic step is to realize that if you operate your business as a sole proprietorship or partnership you will have many worries about losing your personal assets to business-related liabilities and increasing your chances of an audit!

The solution is to create an entity that has limited liability. Your choices are S and C corporations and LLCs. With the LLC we will need to address both the single and multi-member LLC. NCP prefers LLCs taxed as partnerships, which means, it would have two members. Most states allow a single member LLC. This is being recommended by tax practitioners to replace the sole proprietorship. In general it provides liability protection and an uncomplicated tax picture.

The $50,000 Tax Error
One Wrong Selection… One (yes, just one) Overlooked Form…
And $50,000 Went Down The Drain For One Unfortunate Soul!

Only the member’s investments in the LLC and the assets in the LLC are generally exposed to liabilities created by business operations. Personal assets are protected (unless someone can pierce through the LLC veil, a key reason to form your LLC in Nevada).

Another Reason NOT to Rely On Online Information...
The Options NEVER Come UP!

Many CPAs will recommend a single member LLC to someone who is currently a sole proprietorship. For federal income tax purposes, the IRS ignores a single-member LLC. That means the single-member LLC will be treated as a sole proprietorship. You would continue reporting business income and expense on Schedule C and computing self-employment tax on Schedule SE (an LLC taxed as a partnership will not file a Schedule C.). Schedule C is very highly audited! NCP has a different opinion for sole proprietorships that is also shared by many other CPAs.

Are You In the Direct Sales Industry?
An LLC Taxed as an S Corporation May be Your Best Option --- IF You Have All The Facts

The LLC taxed as a partnership (with two members) will file a minimally audited Schedule E. If you take money or assets out of the LLC, there are no Federal tax complications (taxed as a sole proprietorship). The same is true if you move money or assets into the LLC.

Procedure: Converting a sole proprietorship into a single-member LLC usually only involves filing a registration form with the appropriate state agency and paying a fee. Then the assets of the proprietorship are moved into the LLC as a tax-free transaction.

Downside: You can’t deduct retirement plan contributions in figuring SE tax. You can’t form an ERISA pension plan either. If you are not an LLC taxed as a partnership there is no charging order protection of the individual operating the sole proprietorship if he or she gets sued personally.* In an LLC taxed as a partnership, the manager, will be subject to SE taxes.**

Another Option Over the Single Member LLC and
Possible Multiple Member LLC is to Save Payroll
Taxes and Reduce Liability with S Corporation Status

Like LLCs, S corporations offer owners protection against liabilities generated by their businesses. Specifically, S corps can take advantage of pass-through taxation, meaning there generally is no corporate-level federal income taxes to worry about. Instead, all the company’s income, deductions and tax credit items are "passed through" to the shareholders, which then report everything on their Form 1040 and pay the taxes.

In contrast, running your business as a C corporation can result in double taxation, meaning your business income gets taxed once at the corporate level and again when liquidated or where there are retained earnings. Keep in mind this is a simplistic answer. There are many advantages to a C corporation also and the effects of double taxation can be minimized or eliminated, as you will soon see.

S corporations have strict qualification rules:

• The corporation must have only US shareholders, estates or specific types of trusts and can only have one class of stock.
• There must not be more than 75 shareholders.

You must also consider these major disadvantages to an S corporation:

1. The stock of an S corporation is very difficult to protect from a personal lawsuit, whereas the stock of a C corporation can be held by a family limited partnership or an LLC taxed as a partnership.
2. In some states, S corporations are taxed and must file a state level tax return.
3. If the S corporation owns appreciated assets, they cannot be distributed to you without triggering an income tax bill. There is no such problem with a single member LLC.
4. If you die, the company cannot step up the basis of its assets to reflect the fair market value on the date of death. With a single member LLC and LLC taxed as a partnership, your heirs benefit from a step-up for most business assets.

Now, let’s look at the tax benefits of an S corporation over the single person and LLC taxed as a sole proprietorship.

As the shareholder-employee of a solely owned S corporation, you receive a salary, subject to a 15.3 percent federal payroll tax (for Social Security and Medicare) on the first $102,000 and 2.9 percent on the excess (for 2008). The corporation, as your employer pays half, and the other half gets withheld from your paychecks. The corporation deducts your salary as a business expense on its tax return (Form 1120S).

Under current law, that pass-through income is not subject to SE tax. In contrast, all income from an LLC  could be subject to SE tax.

Strategy: Pay yourself a low salary to avoid federal payroll taxes. Just make sure it’s not too low. Have industry comparisons on hand to show you’re in the ballpark.

Example: The taxable income generated by your S corporation business is estimated to be $100,000 for 2008 before you pay yourself. You take a $50,000 salary. Only that amount is hit with the 15.3 percent federal social security and Medicare tax, which amounts to $7,650. You can withdraw the remaining corporate cash flow in the form of distributions to yourself that will not be subject to SE taxes (this will be added to your personal income on which you will pay tax at your current tax bracket).

If you operate the same business as an LLC where each member is subject to SE taxes, you owe SE tax on your entire $100,000 profit, for a total of $13,427.60 (15.3 percent of the first $102,000). So operating as an S corporation could save you thousands ($13,427.60-$7,650= $5,777.60).

Remember: You must be able to show that a $50,000 salary is reasonable. If the IRS thinks it’s too low, it may try to reclassify all or part of your purported cash distributions as disguised wages.

Select C corporation status when profits are on the rise.

Like S corporations, the main advantage of a C corporation is the personal protection from business liabilities. The big disadvantage of C corporations is that retained earnings are subject to double taxation, which in turn can mean:

• Payments to shareholders-in cash or property-may be treated as dividends (ordinary income to shareholders with no deduction for the company).
• Two layers of tax on retained corporate cash flow (once when the corporation earns income and again on the resulting increase in stock value when shares are sold).
• Both corporate and shareholder-level taxes when the company holds appreciated assets and liquidates so shareholders can go their separate ways.
• Ditto if the corporation sells all its assets and gives the resulting cash to its shareholders in liquidation.

Also, if the business will have significant losses in the startup phase, they can’t be passed through to the owner (they will carry forward and offset profits from year two). With an LLC or S corporation, losses can generally be passed through and deducted against other personal income.

Here is a way to Pay Less to the IRS with
C corporation Strategies

A C corporation can actually be the best bet when you don’t anticipate startup losses and you can avoid double taxation. Here are two techniques for keeping taxes to a minimum.

Caution: Your Tax Professional MUST be on Top Of Your Records for Your C Corporation Strategy to be Effective!

Strategy 1: Try to "zero out" the company’s taxable income every year with deductible payments that benefit you. These payments can include salary, bonuses, and fringe benefits, rent for assets owned by you and leased to the corporation and interest on loans from you to the company. If the company’s income can be zeroed out, double taxation is no threat.

Strategy 2: Use a C corporation for a growth business when you need to maximize cash flow to finance equipment additions and growing levels of inventories and receivables.

Example: You have a great idea for a new business. Personally, you’re already in the 39.6% tax bracket because of income from other sources. The new business will make money, but you need to maximize cash to finance growth. If you set up as a single-member LLC or S corporation, you’ll have to withdraw 39.6 percent of the new venture’s income each year just to pay your personal taxes.

But if your set up as a Corporation, the company pays only 15 percent on its first $50,000 of taxable income and 25 percent on the next $25,000. In fact, you can have taxable income up to $10 million and pay a highest rate of only 34 percent.

Comparison of LLCs and S and C Corporations:

	LLC * (depends on how LLC is taxed)	S Corporation	C Corporation
Tax at personal level	Distributions may be subject to SE taxes.	After salary, remaining distributions are not subject to SE	Not a flow through entity; it files its own tax return.
Entity Tax Rates	No tax at entity level	No tax at entity level (usually)	15% on first $50,000 in profits.
Asset Protection at Personal Level	May be partial or complete at personal level (depends on how the LLC is taxed).	None	None

Ready to Incorporate, Build Business Credit & Keep the IRS Off Your Back? Call NCP Today at 1-800-351-5111 Avoid Costly Mistakes!

 

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