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I am thinking about starting a new business venture and I am

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trying to decide whether to...
I am thinking about starting a new business venture and I am trying to decide whether to operate as a sole proprietorship or incorporate. I anticipate the business will generate approximately both annual taxable income and cash flow of $100,000. At the present time, my personal marginal tax rate is 35% and I do not expect that to change with the launch of the new business. One major concern I have is to make sure I have the ability to generate sufficient funds for reinvestment in the business.

Question 1: If I assume that I will make no withdrawals from the business, would my after-tax cash flows available for reinvestment be better if the business were operated as a sole proprietorship or as a regular (C) corporation?

Question 2: What are the tax consequences to me and the business if I operate as a sole proprietorship and withdraw $20,000 annually from the business? How much after-tax cash flow will remain for investment and how much will I have after-tax from the withdrawal?

Question 3: What are the tax consequences to me and the business if I operate as a C corporation and withdraw $20,000 in the form of a dividend? How much after-tax cash flow will remain for investment and how much will I have after-tax from the dividend? Would I better off to organize as an S Corporation? Why?
Submitted: 5 years ago.Category: Tax
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12/2/2011
Tax Professional: CGCPA, CPA replied 5 years ago
CGCPA
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Category: Tax
Satisfied Customers: 3,820
Experience: over 40 years experience in tax matters
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Welcome to Just Answer. I am here to help you resolve your tax and finance concerns. Please feel free to ask anytime you need extra help.

First, let's address the corporation vs sole proprietorship issue since it is a major decision and impacts all else. I personally advise all my clients starting a new venture to either form a corporation (coupled with an S Corporation election) or an LLC. The reasoning is that either structure legally separates your venture and its activities from your personal life. Then, if there is a lawsuit or other problem, the business stands on its own and your other personal assets and income cannot be touched. After the remainder of my remarks I will provide some information concerning each of these (in separate posts) to help you understand this a bit more.

1.The after cash tax flows in either of these choices would be about the same with one exception. As a sole proprietor you would be subject to the Self Employment tax (a corporation is not subject to that) which is a tax of approximately 13% for Social Security and Medicare. This would bring the sole proprietorship net cash available lower than that of a corporation.

2.As a sole proprietor you are taxed on the business profit whether or not you take it out. Accordingly, there would be less available for business reinvestment in a sole proprietorship. The net available would be about 52% after taking into account your 35% tax rate and the 13% self employment tax.

3.Please see my earlier remarks.

Now, onto the S Corp/LLC issue. You should choose whichever is less costly to form. The ongoing cost is similar but the formation costs vary by state and locale within a state. NY is less costly for an S Corporation than an LLC, some states the opposite is true. Information in the next posts.

CGCPA
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Category: Tax
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Tax Professional: CGCPA, CPA replied 5 years ago

Here is information about the S Corporation. It is from the IRS:


<table border="0" cellspacing="0" cellpadding="0">



S Corporations










S corporations are corporations that elect to pass corporate income, losses,
deductions and credit through to their shareholders for federal tax purposes.
Shareholders of S corporations report the flow-through of income and losses on
their personal tax returns and are assessed tax at their individual income tax
rates. This allows S corporations to avoid double taxation on the corporate
income. S corporations are responsible for tax on certain built-in gains and
passive income.

To qualify for S corporation status, the corporation must meet the following
requirements:




  • Be a domestic corporation

  • Have only allowable shareholders


    • including individuals, certain trust, and estates and

    • may not include partnerships, corporations or non-resident alien
      shareholders


  • Have no more than 100 shareholders

  • Have one class of stock

  • Not be an ineligible corporation i.e. certain financial institutions,
    insurance companies, and domestic international sales
    corporations.

In order to become an S corporation, the corporation must submit Form 2553 Election by a Small Business
Corporation
(PDF) signed by all the shareholders.


Filing Requirements:

























Chart 1 - S Corporation
id="tbl845id0_0" align="top" valign="top" scope="col">If you are an S
corporation then you may be liable for...
Use
Form...
Separate
Instructions...
Income Tax

1120S (PDF)
1120S Sch. K-1 (PDF)


Instructions for Form 1120S (PDF)
Instructions for Form 1120S Sch. K-1
(PDF)

Estimated tax1120-W
(PDF) (corporation only) and 8109
Instructions for Form
1120-W
(PDF)

Employment taxes:




941 (PDF) ( 943 (PDF) for farm employees)


940 (PDF)
8109


Instructions for Form 941 Employers QUARTERLY
Federal Tax Return
(PDF)

Instructions
for Form 943 Employers Annual Federal Tax Return for Agricultural Employees

(PDF)


Instructions for Form 940 Employers Annual
Federal Unemployment (FUTA) Tax Return
(PDF)

Excise TaxesRefer to the Excise Tax web
page

















Chart 2 - S Corporation Shareholders

If you are an S corporation
shareholder then you may be liable
for...

Use
Form...
Separate
Instructions...
Income Tax1040 and Schedule E (PDF)Instructions for
Schedule E (Form 1040)Supplemental Income and Loss (PDF)
Estimated tax1040-ES
(PDF)

References/Related Topics


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Tax Professional: CGCPA, CPA replied 5 years ago

Here is the LLC information, also from the IRS:










Limited Liability Company (LLC)






A Limited Liability Company (LLC) is a business structure allowed by state
statute. LLCs are popular because, similar to a corporation, owners have limited
personal liability for the debts and actions of the LLC. Other features of LLCs
are more like a partnership, providing management flexibility and the benefit of
pass-through taxation.

Owners of an LLC are called members. Since most states do not restrict
ownership, members may include individuals, corporations, other LLCs and foreign
entities. There is no maximum number of members. Most states also permit "single
member" LLCs, those having only one owner.


A few types of businesses generally cannot be LLCs, such as banks and
insurance companies. Check your state's requirements and the federal tax
regulations for further information. There are special rules for foreign
LLCs.


Classifications


The federal government does not recognize an LLC as a classification for
federal tax purposes. An LLC business entity must file a corporation,
partnership or sole proprietorship tax return.


An LLC that is not automatically classified as a corporation can file Form
8832 to elect their business entity classification. A business with at least 2
members can choose to be classified as an association taxable as a corporation
or a partnership, and a business entity with a single member can choose to be
classified as either an association taxable as a corporation or disregarded as
an entity separate from its owner, a "disregarded entity." Form 8832 is also
filed to change the LLC's classification.


Effective Date of Election


The election to be taxed as the new entity will be in effect on the date the
LLC enters on line 8 of Form 8832. However, if the LLC does not enter a date,
the election will be in effect as of the form's filing date. The election
cannot take place more than 75 days prior to the date that the LLC files Form
8832 and the LLC cannot make the election effective for a date that is more than
12 months after it files Form 8832. However, if the election is the "initial
classification election," and not a request to change the entity classification,
there is relief available for a late election (more than 75 days before the
filing of the Form 8832).


References/Related Topics


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