There are no hard and fast rules as to what is the best way to structure a business, and naturally, the decision will be based on your own individual circumstances. But there are certain pro’s and cons to each business structure that you should be aware of, as there are certain rules that regulate the way business may be conducted in the United States.
Strategy – Select a “C” Corporation form of Business Organization when you have both a strong desire and opportunity to “Grow” the business (increase sales) by keeping dollars in the business, and are liable for higher personal income tax rates as the business’ owner(s).
Any number (one or more) of individuals can be the owner(s) of a “C” Corporation. These owner(s) can take compensation out of a “C” Corporation in the form of W-2 wages, paid to themselves and/or their spouse.
Owners may wish to keep the dollars of profit in the business to “Grow” the business’ sales. This type of growth may require additional funding, particularly in one or more of the following areas: cash flow reserves, accounts receivables, inventory and equipment. Dollars that are kept in a “C” Corporation are taxed at “C” (Regular) Corporation rates, displayed below:
Taxable Income Tax Rate
Not over $50,000……………………………………………..15%
Over $50,000, but not over $75,000………………..25%
Over $75,000, but not over $100,000……………..34%
Over $100,000, but not over $335,000……………39%
Over $335,000, but not over $10,000,000………34%
Over $10,000,000 but not over $15,000,000….35%
Over $15,000,000 but not over $18,333,333……38%
Over $18,333,333…………………………………………….39%
Corporations are legal entities that require filing with the state government. They are separate entities that require their own tax to be filed with the IRS (IRS form 1120). A “C” corporation is taxed separately on all monies that are not paid out in expenses, bonuses, or salaries. Corporations are very formal beasts. In fact, based on the complexity and formalities involved, corporations can be unwieldy, so you should carefully consider each of the pros and cons of incorporating.
Advantages
- The biggest advantage is that corporations limit liabilities. If you maintain the formalities, your liabilities are generally limited to assets of the corporation with the exception of malpractice suits. (In malpractice, the owners may be unconditionally liable regardless of the way the business is structured.)
- You can deduct 100 percent of health insurance premiums and 100 percent of any disability insurance premium, which are both tax free benefits to employees.
- With planning, you can accumulate $50,000 per year for future business needs and have this amount taxed at the 15 percent rate. If you are in a 40 percent tax bracket, this represents a 25 percent savings. I should note here that this is a major overlooked advantage of being a regular corporation. If you want to accumulate substantial working capital, this allows you to keep up to $50,000 per year and have it taxed to the corporation at only the 15 percent tax bracket.
- You can have many different classes of public or private stock, which adds value to the company and is great for estate planning and raising capital.
Disadvantages
- If funds are paid out again in dividends, you can be “double taxed” on these dividends, meaning that the funds would be taxed first through the business entity, and then taxed to you as a dividend. In fact, based on the complexity and formalities involved, double taxation is the biggest headache of incorporating. I should note however that this headache can alleviate with proper year-end tax planning with your accountant.
- You must hold yearly stock holder meetings, even if you are the only stockholder, and yearly board of director meetings.
- You must have a separate business bank account; if you do not take this step and co-mingle your personal funds with business funds, you will automatically forfeit your legal protection against liability. (While it is advisable for all business entities, including sole proprietorship’s to set up separate business bank accounts and distinguish between all business and personal funds, corporations are legally bound to do so.)
- Must obtain a federal tax ID number from both the IRS and the state.
- Some states impose strict taxes on corporations. For example, California requires that a corporation pay what the state’s normal tax rate would be or $800!
- If planning has been done poorly or incorrectly, the corporation will be subject to potentially nasty surprises such as having to pay taxes on accumulated earnings (also called “future income”).
- Can be very expensive and costly to file taxes because of the amount of paperwork required.
Tip: Because liability protection is so important in making the decision of whether to incorporate, I almost always recommend some form of corporation or LLC (Limited Liability Company) if workers are employed. If you have employees, you MUST limit your liability through the legal protection allowed by incorporation laws. For example, if you are incorporated and one of your employees accidentally burns your restaurant to the ground through a grease fire, you will not be responsible to pay for the loss of the building personally unless you have assumed or guaranteed any indebtedness. Responsibility for the building is transferred to the business entity itself.
Cautionary Note: If you are a “personal service corporation” you will be taxed on any money left in the corporation at the end of the year at a flat 35% rate. A personal service corporation is a regular “C” Corporation whose principal activity is the performance of personal services by its employee-owners. They also involve certain occupations such as law, medicine, accounting, architecture, veterinary, dental, etc. If you are in these fields, you should consider very carefully whether to structure your business as a “C” Corporation or, at the very least, conduct yearly year-end tax planning in order to insure that most of the profits are removed from the corporation in the form of salaries or bonuses.
Hot Tip: Because many business owners don’t keep up with the required formalities and don’t perform the required year-end tax planning necessary to avoid double taxation, I rarely recommend structuring your business as a regular “C” corporation. This should only be set up with careful advice from your lawyer and/or accountant.
One final thought on multiple ownerships within partnerships, LLC’s or corporations. What happens if you and one other owner in your business do not get along? Bad relationships have resulted in some of the most expensive and protracted legal battles around. This kind of business contention is as bad as a divorce.
Thus, take the following advice:
If you incorporate and have multiple owners, always set up a “buy-sell” agreement at the launch of your business. This will eliminate a lot of problems you could encounter later. Think of “buy-sell” arrangements as some sort of business prenuptial agreement.
As I have already noted, the way you formally structure your business can protect you from liabilities and save you thousands of tax dollars depending on your personal circumstances. I strongly recommend that you seek out the professional help of your accountant or attorney in order to sort out which business structure is best for you.
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