Advantages & Disadvantages of Business Forms

Advantages & Disadvantages of Business Forms
Choosing the Right Business Form
Overview:  There are three basic business forms available for most business owners:

• Proprietorship (Schedule C)
• Regular Corporation (C Corporation)
• S Corporation

The matrix on below provides an excellent overview of the differences.  This section highlights important strategies for the different forms of business.

Description	Schedule C Proprietorship	Regular Corporation	S Corporation
Reasonable salary*	Not an issue	Deductible	Deductible
Unreasonable (excessive) salary	Not an issue	Not deductible by corporation;  dividend to shareholder/employee	Generally, not an  issue for shareholder/ employees
Social security taxes	Self-Employment tax based on bottom-line Schedule C income	Taxed 50% to  corporation and 50% to employee	Same as regular corporation
Net income	Taxed at individual tax rates	Taxed at corporate tax rates	Taxed at individual tax rates
Net loss	Deducted on individual return against other income; unabsorbed losses may be carried back 2 years and forward 20 years	Net loss on corporate return is carried back 2 years and forward 20 years	Deducted and carried back  and forward  on individual  return up to shareholder’s  basis in stock and loans  to corporation
Medical insurance premiums on owner	Deduct 100% on front of Form 1040	Deducted on corporate return	Same as proprietorship including ability to deduct 100% on front of Form 1040
Disability premiums on owner	Not deductible	Deductible to corporation; taxable to recipient of benefits	Not deductible by corporation or individual
Group term life insurance premiums on life of owner	Not deductible	Deductible as a tax-free fringe benefit on first $50,000 of coverage	Not deductible
Retirement benefits	Basically same as corporation	Basically same as individual	Basically same as individual
Supper money for owner	Not deductible	Deductible	Questionable
Election required	No	No	Yes – strict time limits
Ownership	Individual	Stock can be more than one class	Only individuals, estates, and trusts restricted to one class of stock (voting rights can differ)
Liquidation of ownership	Assets are sold and individual is taxed	Sale of stock or sale of assets and liquidation of corporation (double-tax problem)	Sale of stock or assets, no double tax problem, except for “built in gains”
Liability	Individual	Corporate, except for professional   corporations  wherein  professionals  remain liable under malpractice statutes	Same as regular corporation
Asset expensing IRC §179	Up to $500K if assets placed in service total less than $2MM	Claimed on  corporate return  with same  limits that apply  to an individual	Reflected on S Corporation  return and claimed  on individual return
Paperwork	Simplest form	Two separate entities for income tax purposes… payroll taxes… corporate minutes	Same as regular corporation;  however, may involve  more complex  state filing requirements
Hiring child	No social security tax if child under 18	Social security taxes apply	Social security taxes apply (may gift stock to children and eliminate social security on distribution, in addition, can still benefit from shifting income).

* Reasonable compensation:  Services performed by shareholder/owners must be reasonable compensated.  Reasonable compensation is subject to wide discretion. (Roob v. Commissioner, 50 TC 891, 898 (1968).  See Radtke vs. US; 712F. Supp. 143; Aff'd 895 F.2d 1196 (1990) in which no compensation was paid).   It must take into account: 

• Services performed
• Responsibilities involved
• Time spent
• Size and complexity of business
• Prevailing economic conditions
• Compensation paid by comparable firms for comparable services
• Salary paid to company officers in prior years

General Rules of Thumb

1. High medical expenses -- regular corporation
2. High disability premiums -- regular corporation
3. Income $20,000 to $70,000 -- S-Corporation to save social security taxes
4. High liability exposure -- corporation
5. Hiring children -- Sole proprietorship
6. Gift/Leaseback -- any form, but assets must be owned individually to create benefits
7. Appreciating assets -- S-Corporation or proprietorship

Reference:  Botkin, Sandy, Tax Strategies for Business Professionals, The Tax Reduction Institute