Tax Tip of the Week- Tax and Asset Protection Considerations

“Success is the sum of small efforts repeated day in and day out.”

                                  -Robert Collier, Author

When your accountant or attorney wants to discuss entity choice, they are referring to the various types of business entities or structures available.  Generally speaking, the relevant options available for most businesses including start-ups are:

1.   LLCs (limited liability company)
2.   S corporation
3.   C corporation
4.   Limited partnership
5.   General partnership
6.   Sole proprietorships

When considering the pros and cons of each type of entity, the many multifaceted issues may be grouped into two broad categories:

A.   Taxation
B.   Asset protection

Taxation
Taxation issues may vary significantly by entity choice.  For example, the sale and liquidation of a C corporation may result in double taxation whereas the sale of an S corporation, LLC, or a partnership may result only in single taxation.  Entity differences also exist between the different categories of income - ordinary, capital gain, passive, investment, and self employment income, all of which may be taxed at different rates.

Taxable compensation inside corporations is affected by the number of owners and their involvement in the business.  For both C and S corporations, reasonableness of compensation can be a huge issue. For C corporations, the issue can be whether an owner’s salary is too high in comparison to any dividends paid.  For S corporations, the issue is whether the salary is too low in relation to distributions paid.

Often, in the early years of a business or in today’s economy, the ability to use losses can be important in the choice of a business structure. Generally speaking, third party debt may create tax basis for owners.  In this respect, LLCs, partnerships, and sole proprietorships provide better opportunities for passing through losses to the owners than do S corporations.

Asset Protection
Asset protection will vary by state and type of entity.  One should consult with his or her attorney for the particular details.  Remember that limited liability or asset protection is usually designed to protect the owner’s personal assets and not to protect the entity itself.  Thus, the entity may not be the safest place to save money.

Please let us know if you have any questions while walking through this mine field of entity choice.  Future laws will affect this process as well.  Sometimes, one entity may be later exchanged for another but often in reality you may be locked into your existing structure, thus, making entity choice a very important decision.

Thank you for all of your questions, comments and suggestions for future topics. As always, they are much appreciated. We also welcome and appreciate anyone who wishes to write a Tax Tip of the Week for our consideration. We may be reached in our Dayton office at 937-436-3133 or in our Xenia office at 937-372-3504. Or, visit our website.
 
This Week’s Author, Mark Bradstreet

-until next week