Real Business Plans

INCORPORATION
GUIDE

 


    

 

Why Should You Incorporate

 

A corporation or LLC is considered a entity onto itself; separate from the individual personal assets of shareholders, officers and directors.

A C-Corp is a corporation which remains a taxable entity within itself. It pays corporate income tax rates, and the profit or loss does not pass through to the individual's tax return. A C-Corp may, in fact, also be subject to personal holding company surtax on the income. An even more serious consideration is the fact that C Corps are subject to double taxation.  The corp. pays taxes on profits, then the shareholders pay tax on dividends received.

 

A sub-chapter 'S' corporation or LLC is essentially an entity which acts and looks like a corporation but is taxed on the individual's tax return (merely a tax code election). The flow-through nature of this entity makes it the preferred vehicle for many businesses.  The corp. itself does not show profits or losses, they must be passed on to the shareholders.  If the corp. has a profit of $100,000 for the year, the money is split among the shareholder percentages.  Each shareholder is liable for the taxes on the dividend received.  The same goes for losses!  These are reported on form K-1 on the Fed tax return.

A second reason for establishing an S-corp or LLC is that of asset protection. An S corporation is a stand-alone entity, even though it is taxed on an individual's tax return. Because of this, anybody suing you as an individual would not generally be able to get to the assets of the S-Corp. Similarly, anyone suing the S-Corp would not be able to get at the assets of the individual outside of the corporate entity. (the corporate entity must be properly maintained)

For these reasons, we have frequently suggest our clients to start S-corps, limited liability companies, and/or limited partnerships.  


 

Case Study: Employed individual with sub 'S' corporation

When Aubry Phillips, a registered nurse, decided to supplement her income by forming a new online medical service.  She formed a corporation and elected the 'S corporation' option for taxes.

One important tax test of a valid 'S corporation' is that it has a legitimate profit objective.  Whether the company profits or not, the income (or loss) effects personal ordinary income.

In the first year, Aubry had a loss from the corporation of $15,000. She was able to deduct the corp.'s loss from her ordinary RN income of $60,000. Consequently, she received a federal income tax refund of $4,500 and a state income tax refund of $1,200.  Her refunds totaled $5,700 which Aubry invested into her business for year two.
 

 


Similarly, year two created another loss with the tax refunds reinvested in the growth of the corporation. By the end of year three, the corp. was profitable.

With the corp. Aubry was allowed several deductions based on company expenses. A car was leased for the business, paid for by the corporation (the insurance as well). She passed a corporate resolution allowing all medical expenses of the officers and directors to be paid by the corporation. Her telephone, computer, web site, internet access, advertising, legal, professional and promotional fees were all ordinary and necessary
expenses of the corporation. These expenses all contributed to her corporate losses and resulted in her personal tax refunds.

This brief example demonstrates the purpose of the IRS Sub 'S' treatment by helping to finance new business during their developmental stages. Also, eliminating double taxation that large corporations are required to pay via a corporation tax and shareholders' dividend taxes.

 

See our Services page for more on financial projections, offering memorandums, business plans, etc.

 

 

 

   

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