Software of the Month Club 1997 March/Software of the Month Club 1997 March.iso/pc/dos/lg/sba/f117.sbe

Text File | 1996-10-08 | 17.1 KB | 379 lines

@212 CHAP 2

        ┌────────────────────────────────────────────────┐
        │SELECTION OF LEGAL ENTITY -- OVERVIEW OF CHOICES│
        └────────────────────────────────────────────────┘

@IF901xx]Your business has not yet started up.  Thus you still have an
@IF901xx]opportunity to select the most favorable type of legal entity
@IF901xx]for @NAME when it comes into being.
@IF901xx]
@IF901xx]The following outline and summary will give you a fairly
@IF901xx]detailed overview of which type of entity is likely to be
@IF901xx]best for your particular business, which you have indicated
@IF901xx]is in the field of @BUSTYPE.
@IF901xx]
@IF900xx]Your firm, @NAME, has already selected
@IF900xx]a form of doing business, which is a @ENTITY.
@IF900xx]
@IF900xx]However, it is possible that your choice of legal entity is
@IF900xx]not the optimum alternative for your particular business and
@IF900xx]personal needs.  The following outline and summary will give
@IF900xx]you some basic guidance as to whether you should explore the
@IF900xx]possibility of switching to some other legal form of business
@IF900xx]organization at this point in the game.
@IF900xx]
Choosing the "best" legal form or entity for your business
is rarely an easy decision to make.  Each form of business,
sole proprietorship, partnership, and corporation, has its
own benefits and shortcomings, which vary in degree depending
on the kind and size of your business, your tax situation,
profitability, personal predilections, and numerous other
factors, some of which may seem important to you, others of
which may not.  Thus there is often no "right" answer as to
which legal entity you should select for operating your
business.

The following is a thumbnail sketch or overview of some of the
major advantages and disadvantages of sole proprietorships,
partnerships, and corporations.  Where there are differences
between a general partnership and a limited partnership, or
between a regular ("C") corporation and an S corporation,
separate comments are shown for each.  Otherwise, the
comments below regarding partnerships apply to both general
and limited partnerships, and the comments regarding
corporations relate to both regular and S corporations.

Because every state has by now adopted legislation permitting
the creation of a new kind of legal entity, called a "limited
liability company" (LLC), which is much like a partnership,
but with limited liability for all its owners, the following
discussion also includes consideration of such "LLCs" in
@STATE.

@CODE: CA
However, note that any business required to obtain a license
from the state, such as physicians, dentists, beauty shop
operators, or auto mechanics, is prohibited from forming an
LLC under California's LLC law.

@CODE:OF
As a general rule, it seems that some types of businesses
are much more likely than others to benefit from adopting a
certain legal form, as in the case of the following (press
<Enter> key for details on highlighted words):

      .ΣProfessional service firmsΦ(law, accounting, etc.);            \113

      .ΣCapital-intensive firmsΦneeding to accumulate capital;         \114

      .ΣReal estate rentalΦbusinesses, in general; and                 \115

      .ΣAuthors, inventorsΦand software developers receiving           \116
        royalty income for licensing intellectual property.



                  SIMPLICITY IN OPERATION AND FORMATION:

    .ΣProprietorshipΦ      Simplest to establish and operate.          \110

    .ΣGeneral PartnershipΦ Relatively simple, informal, but            \111
                           is usually desirable to have formal
                           written agreement between the
                           partners.

    .ΣLimited PartnershipΦ More complex and expensive than             \112
                           other unincorporated forms of
                           business to establish.  Requires
                           written agreement, filing of
                           limited partnership certificate.
                           Managed by general partners only.

    .ΣLim. Liability Co.Φ  A new type of entity, which your            \406
                           lawyer may not yet be very familiar
                           with.  Requires written articles of
                           organization, roughly comparable to
                           corporation or limited partnership
                           in terms of complexity in formation.
                           Can be formed under the state laws
                           of @STATE.

    .ΣRegular CorporationΦ Requires the most formality in              \135\231
                           establishment and operation,
                           generally.

    .ΣS CorporationΦ       Same as regular corporation, but            \234
                           requires close oversight by a
                           tax advisor, an additional cost.

                  LIABILITY FOR DEBTS, TAXES & OTHER CLAIMS:

    . Proprietorship       Owner has unlimited personal
                           liability.

    . General Partnership  Partners all have unlimited
                           personal liability.

    . Limited Partnership  General partners are personally
                           liable; limited partners are
                           liable only to the extent of their
                           investment, generally.

    . Lim. Liability Co.   "Members" (owners) not generally
                           liable for company's debts, under
                           the state laws of @STATE.
                           But may have to guarantee loans,
                           as a practical matter, if company
                           is to be able to borrow money.
                           Also, corporate officers may be
                           liable for failure to withhold
                           and pay over to IRS, withholding
                           taxes on employees' wages.

    . Corporation          Stockholders not generally
                           liable for corporate debts, but
                           often have to guarantee loans,
                           as a practical matter, if the
                           corporation is to borrow money.
                           Also, corporate officers may be
                           liable for failure to withhold
                           and pay over to IRS, withholding
                           taxes on employees' wages.

                  FEDERAL INCOME TAXATION OF
                  BUSINESS PROFITS:

    . Proprietorship       Taxed to owner at individual
                           tax rates of up to 39.6%.

    . Partnership          Taxed to partners at their
                           individual tax rates.

    . Lim. Liability Co.   Taxed to owners at their individual
                           tax rates, if organized so as to
                           be taxed as a partnership for
                           federal income tax purposes.
@CODE: AK FL PA
                           (Note, however, that for @STATE
                           state income tax purposes, an LLC
                           is taxed as a corporation.)
@CODE:OF

    . Regular Corporation  Taxed to corporation at rates
                           up to 34%, generally (marginal
                           rate is 39% at income levels of
                           between $100,000 and $335,000;
                           rate rises to 35% above $10
                           million of taxable income).

    . S Corporation        Taxed to individual owners at
                           their individual rates (but
                           certain gains are taxable to
                           the corporation as well).

                  DOUBLE TAXATION IF PROFITS ARE WITHDRAWN
                  FROM THE BUSINESS:

    . Proprietorship       No.

    . Partnership          No.

    . Lim. Liability Co.   No, generally, if treated for tax
                           purposes as a partnership.

    . Regular Corporation  Yes. (But major exception exists
                           forΣreasonable compensationΦ that           \105
                           is paid to owners who are employees
                           of the corporation.)

    . S Corporation        No, in general.

                       DEDUCTION OF LOSSES BY OWNERS:

    . Proprietorship       Yes.

    . Partnership          Yes.  Limited partner's deductions
                           generally cannot exceed the amount
                           he or she has invested in a
                           limited partnership interest
                           (except for real estate, in some
                           instances).

    . Lim. Liability Co.   Yes, generally, if treated as a
                           partnership for tax purposes. Tax
                           treatment not totally resolved yet,
                           but may actually have advantages
                           over limited partnerships for
                           holding real estate.

    . Regular Corporation  No.  Corporation must carry over
                           any initial losses until able to
                           offset them against future profits,
                           if ever.

    . S Corporation        Yes, in general, for federal tax
                           purposes. Loss for a shareholder
                           is limited to investment in his
                           or her stock, plus amount loaned
                           to corporation.

               SOCIAL SECURITY TAXES ON EARNINGS OF
               OWNER FROM THE BUSINESS:

    . Proprietorship       15.3% of owner'sΣself-employmentΦ           \262
                           earnings in 1996, up to $62,700
                           of income, plus 2.9% of S/E
                           in come over $62,700.   (ALL S/E
                           earnings are subject to the 2.9%
                           Medicare tax in 1994 and subsequent
                           years.)  One-half of the S/E tax
                           is deductible for federal income
                           tax purposes.

    . Partnership          15.3% of each partner's share of
                           self-employment earnings from
                           the business in 1996, on up to
                           $62,700 of such earnings, plus
                           2.9% on excess over $62,700
                           (cut-off was $61,200 in 1995).

    . Limited Partnership  15.3% of each general partner's
                           share of self-employment earnings
                           from the business in 1996, on up
                           to $62,700 of such earnings, plus
                           2.9% on excess over $62,700. (The
                           earnings of limited partners are
                           not subject to S/E tax, generally.)

    . Lim. Liability Co.   Same as partnership, if LLC is
                           is organized in such as way as to
                           be recognized as a partnership
                           for tax purposes.

    . Corporation          Owner/employee of corporation
                           pays 7.65% on his or her salary
                           and corporation also pays 7.65%.
                           TotalΣSocial Security (FICA) taxΦ           \258
                           is 15.3% of up to $62,700 of salary
                           in 1996 (plus 2.9% on excess over
                           $62,700).  The cut-off amount was
                           $61,200 in 1995.

               UNEMPLOYMENT TAXES ON EARNINGS OF
               OWNER FROM THE BUSINESS:

    . Proprietorship       None.

    . Partnership          None.

    . Lim. Liability Co.   None, if treated as partnership.

    . Corporation          Yes. ΣUnemployment taxesΦ (state            \260
                           and federal) apply to salaries
                           paid to owners.

                         RETIREMENT PLANS:

    . Proprietorship       Keogh plan.  Deductions, other
                           features now generally the same
                           as for corporate pension and
                           profit sharing plans.  But a
                           participant who is owner cannot
                           borrow from a Keogh plan.

    . Partnership          Keogh plan.  Same as for sole
                           proprietorship except that the
                           prohibition on borrowing from
                           plan applies to any 10% or
                           greater partner.

    . Lim. Liability Co.   Same as for partnership, if
                           recognized as partnership for
                           tax purposes.

    . Regular Corporation  Corporate retirement plans no
                           longer are significantly better
                           than Keogh plans.  Deduction
                           limits same now as for Keogh.
                           But participants can borrow from
                           corporate plan, within limits.

    . S Corporation        Plans now essentially identical
                           to regular corporate retirement
                           plans, except that "shareholder
                           employee" (owning 5% or more of
                           the stock) of S corporation can't
                           borrow from retirement plan.

                 TAX TREATMENT OF MEDICAL, DISABILITY, AND
                 GROUP-TERM LIFE INSURANCE ON OWNERS:

    . Proprietorship       Not deductible, except that part
                           of medical expenses may be an
                           itemized deduction on owner's
                           tax return, including medical
                           insurance premiums.  But 30% of
                           medical insurance on owner is
                           now allowed as a deduction in
                           computing adjusted gross income.

    . Partnership          See proprietorship, above.

    . Lim. Liability Co.   Same as partnership, if treated
                           as partnership for tax purposes.

    . Regular Corporation  Corporation may be able to deduct
                           theΣmedical insuranceΦpremiums              \241
                           or reimbursements paid under
                           a medical reimbursement plan.
                           Generally not taxable to the
                           employee, even if employee is an
                           owner, if plan is not considered
                           discriminatory.  Similar treatment
                           is provided forΣdisabilityΦ                 \240
                           coverage and up to $50,000 of
                           coverage (per employee) for
                          Σgroup term life insuranceΦplans.            \242

    . S Corporation        Fringe benefits for 2% shareholders
                           may be deductible by corporation,
                           but such expense will be treated
                           like additional (taxable)
                           compensation to shareholder
                           employees who own more than 2%
                           of the stock of the company.
                           (But may not be subject to FICA
                           tax in the case of medical
                           insurance, if such coverage is
                           provided to employees generally
                           by the S corporation.)

                       TAXATION OF DIVIDENDS RECEIVED
                       ON INVESTMENTS:

    . Proprietorship       Dividends received on stock
                           investments are fully taxable
                           to owner.

    . Partnership          Dividends taxable to individual
                           partners.  See proprietorship,
                           above.

    . Lim. Liability Co.   Dividends taxable to individual
                           members, if treated as a
                           partnership for tax purposes.

    . Regular Corporation  Dividends are taxable to corporation.
                           But aΣspecial deductionΦis allowed          \245
                           for 70% of the dividends received,
                           generally, an important tax
                           advantage (unless the stock is
                           purchased with borrowed money).

    . S Corporation        Dividends are taxable to the
                           individual shareholders of the S
                           corporation, as in the case of
                           dividends received by a partnership.