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Chapter 13 Presentation Transcript

  • 1. Chapter 13
    • Comparative Forms
    • of Doing Business
    Copyright ©2010 Cengage Learning Corporations, Partnerships, Estates & Trusts
  • 2. Choice of Form of Business Entity
    • Many factors affect the choice of business entity
      • Both tax and nontax
      • Understanding the comparative tax consequences related to the different types of entities is important for effective tax planning
  • 3. Principal Forms of Doing Business
    • Sole Proprietorship
    • Partnership
    • C corporation
    • S corporation
    • Limited liability company (LLC)
  • 4. Limited Liability Company (LLC)
    • Hybrid business form that combines the corporate characteristic of limited liability for owners with tax characteristics of a partnership
  • 5. Filing Requirements
    • Sole Proprietorship
    • Files Schedule C,
    • Form 1040
    • Partnership & LLC
    • Files Form 1065
    • C Corporation
      • Files Form 1120
    • S Corporation
    • Files Form 1120S
  • 6. Nontax Factors— Capital Formation
    • Sole Proprietorship
    • Limited ability to raise capital
    • Partnership
    • Can raise funds through pooling of owner resources
    • Ltd. p’ship can raise capital from investors
    • C Corporation
    • Greatest ease and potential for raising capital
    • S Corporation
    • Greatest ease and potential for raising capital, but limited number of investors
  • 7. Nontax Factors— Limited Liability
    • Sole Proprietorship
    • Unlimited liability
    • Partnership
    • General partners are jointly and severally liable
    • Ltd. partners’ liability is limited to investment
    • C Corporation
    • Generally have limited liability
    • S Corporation
    • Generally have limited liability
  • 8. Other Nontax Factors
    • Estimated life of business
    • Number of owners and their roles in management of the business
    • Freedom of choice in transferring ownership interests
    • Organizational formality and related costs
  • 9. Single vs. Double Taxation
    • Sole Proprietorship
    • Single taxation
    • Partnership and LLC
    • Single taxation
    • C Corporation
    • Double taxation
    • S Corporation
    • Generally, single taxation
    • May be subject to built-in gains tax and passive investment income tax
  • 10. Alternative Minimum Tax
    • Sole Proprietorship
    • Directly subject to AMT
    • Partnership and LLC
    • Indirectly subject to AMT
    • AMT adjustments & preferences flow through and partners subject to AMT
    • C Corporation
    • Directly subject to AMT
    • May have advantage here since corp AMT rate is only 20%
    • S Corporation
    • Indirectly subject to AMT
    • AMT adjustments & preferences flow through and S/H’s subject to AMT
  • 11. Controlling the Entity Tax
    • Various techniques can be used to control the tax liability, whether imposed on the entity or owners, such as:
      • Distribution policy
      • Recognizing the interaction between the regular tax liability and the AMT liability
      • Utilization of special allocations
      • Fringe benefits
      • Minimizing double taxation
  • 12. Fringe Benefits (slide 1 of 2)
    • Generally produce the following tax consequences:
      • Deductible by entity (employer) providing the fringe benefit
      • Excludible from gross income of taxpayer (employee) who receives the fringe benefit
  • 13. Fringe Benefits (slide 2 of 2)
    • Favorable tax treatment of fringe benefits is available only to employees
      • For owner of entity to be an employee, the entity must be a corporation
        • Partners in a partnership are not employees
        • Greater-than-2% shareholders in an S corp are treated as partners
      • If not an employee
        • Deduction of cost of fringe benefit is disallowed
        • Owner must include cost of fringe benefit in gross income
  • 14. Minimizing Double Taxation of C Corporations (slide 1 of 5)
    • Several techniques are available for reducing the double taxation of C corps including:
      • Making distributions to shareholders that are deductible by corp
      • Retaining earnings at corp level
      • Making distributions treated as a return of capital
      • Making the S corp election
  • 15. Minimizing Double Taxation of C Corporations (slide 2 of 5)
    • Deductible distributions include:
      • Salary payments to shareholder-employees
      • Rental payments to shareholder-lessors
      • Interest payments to shareholder-creditors
    • IRS scrutinizes these types of transactions
      • Must be reasonable
  • 16. Minimizing Double Taxation of C Corporations (slide 3 of 5)
    • Retain earnings at corporate level
      • Double tax is avoided unless corp makes distributions (actual or deemed) to shareholders
        • Must watch out for accumulated earnings tax problems
      • For distributions made in 2003 and thereafter the 15%/0% rate for qualified dividends reduces the potential negative impact of double taxation
  • 17. Minimizing Double Taxation of C Corporations (slide 4 of 5)
    • Make return of capital distributions
      • For ongoing businesses, redemption provisions may help reduce gross income at the shareholder level
      • Corporate liquidation provisions can be used if business will cease to operate in corporate form
  • 18. Minimizing Double Taxation of C Corporations (slide 5 of 5)
    • Electing S corp status
      • Generally eliminates double taxation but other factors must be considered such as:
        • Will all shareholders consent to election?
        • Can qualification requirements be met currently and on an ongoing basis?
        • Are conditions favorable to an S corp election and how long will those conditions be favorable
        • Distribution policy may cause problems paying tax at shareholder level
  • 19. Entity Formation (slide 1 of 2)
    • Generally, owners make contributions of cash and property to entity in exchange for an ownership interest
      • Generally, tax-free to both the entity and the owner
        • In corporate setting, requirements of §351 must be met
      • Owners and entities take a carryover basis in their ownership interest and in assets contributed, respectively
  • 20. Entity Formation (slide 2 of 2)
    • If FMV of property contributed > adjusted basis, may want to make special allocation
      • Required in partnerships
      • Not available for C corps or S corps
  • 21. Basis Considerations
    • Sole Proprietorship
    • N/A
    • Partnership and LLC
    • Profits & losses affect partner’s basis
    • Partner’s basis is increased by share of p’ship liabilities
    • C Corporation
    • Shareholder’s basis is not affected by corporate profits & losses
    • S Corporation
    • Shareholder’s basis is increased by profits, decreased by losses, not affected by corporate liabilities
  • 22. Distributions
    • Distributions can be made to partners, LLC owners, or S corp. shareholders tax-free
      • The same distribution would produce dividend income treatment for C corp. shareholders
    • If appreciated property is distributed to S corp. shareholders, realized gain is recognized at the corporate level (same treatment as a C corp.)
      • This corporate-level gain is passed-through to the S corp. shareholders
  • 23. Passive Activity Losses (slide 1 of 2)
    • Loss limits apply to owners of partnerships, LLCs, and S corps
      • Passive losses are separately stated items that flow through to owners
      • Passive loss rules apply at the owner level
  • 24. Passive Activity Losses (slide 2 of 2)
    • For corporations, only apply if a closely held corp or a personal service corp
      • Closely held corp—more than 50% of value of stock at any time during last half of year is owned by 5 or less individuals
        • Passive losses can offset active income but not portfolio income
      • Personal service corp—principal activity is performance of personal services by owner-employees who own more than 10% in value of corp’s stock
        • General passive loss rules apply
  • 25. At-Risk Rules
    • At-risk rules apply to:
      • Partnerships
      • LLCs
      • S corps
      • Closely held C corps
    • May be more troublesome for partnerships and LLCs since liabilities are included in partner’s basis in partnership interest
  • 26. Special Allocations
    • Partnership and LLCs have many opportunities to use special allocations
      • Not generally available in C corps and S corps
        • May be able to achieve the same results using payments to owners for services, rents and interest
  • 27. Disposition of a Business or an Ownership Interest
    • Disposing of a business may be viewed as either:
      • A sale of an ownership interest, or
      • A sale of assets
    • Tax consequences are, in general, more favorable for a sale of an ownership interest
  • 28. Sale of Assets by Entity —Seller’s Issues (slide 1 of 3)
    • Sole Proprietorship
      • Treated as a sale of separate assets
      • Gain or loss is calculated for each asset
        • Character of income or loss depends on nature of asset
  • 29. Sale of Assets by Entity —Seller’s Issues (slide 2 of 3)
    • Partnership, LLC, or S Corp—Same as proprietorship
      • Gain/loss flows through to shareholders or partners
        • They report & pay tax on gain or loss
        • Distribution of cash proceeds does not cause double tax since basis is adjusted by gain/loss
  • 30. Sale of Assets by Entity —Seller’s Issues (slide 3 of 3)
    • C Corp—double taxation occurs
      • Gain is determined for each asset and tax paid by corporation
      • Net cash is distributed
        • Taxed as dividend, return of capital or capital gain to shareholder
  • 31. Liquidating Distribution of Assets to Owner Followed by Owner’s Sale to Third Party (slide 1 of 3)
    • Partnership
      • Distribution rules determine partner’s basis in assets received from partnership
      • Partner has gain if cash received > basis
      • Partner has loss if cash, inventory and unrealized receivables are only assets rec’d and are < basis
      • Character of gain on asset sale depends on nature of assets received by partner
      • No double tax
  • 32. Liquidating Distribution of Assets to Owner Followed by Owner’s Sale to Third Party (slide 2 of 3)
    • S Corp
      • S Corp has gain if appreciated assets distributed to shareholders
      • No corporate level tax unless “built-in gain”
      • Shareholder has gain (tax) on receipt of assets > basis (after basis increase for gain)
      • Shareholder’s basis in assets = FMV, so no gain on later sale of assets
  • 33. Liquidating Distribution of Assets to Owner Followed by Owner’s Sale to Third Party (slide 3 of 3)
    • C Corp
      • Double tax
      • Gain on distribution and tax at entity level
      • Net (after tax) assets distributed at FMV & result in gain to shareholder
  • 34. Purchase of Business Assets—Buyer’s Issues (slide 1 of 2)
    • The purchaser of individual assets is not generally affected by the type of entity through which the seller operates:
      • The buyer (whether individual, partnership, LLC, C corp or S corp) allocates the total amount paid to the individual assets acquired
      • Part of the cost may be allocated to intangible assets such as goodwill
  • 35. Purchase of Business Assets—Buyer’s Issues (slide 2 of 2)
    • Asset cost is recovered through depreciation, amortization, sale of inventory, collection of accounts receivable, etc...
    • The buyer can contribute the assets to a partnership or C corp under § 721 or § 351
      • If the C corp is qualified, an S corp election can be made
  • 36. Sale of Business Interest—Seller’s Issues (slide 1 of 3)
    • Sole Proprietorship
      • No distinction between sale of interest or assets
    • Partnership
      • Sale of partnership interest results in ordinary income to partner for share of partnership’s ordinary income assets; capital gain for remainder
  • 37. Sale of Business Interest—Seller’s Issues (slide 2 of 3)
    • S Corp
      • Sale treated as sale of stock
        • Results in capital gain or loss to shareholder
      • In general, no corporate-level consequences
        • However, if purchaser is not qualified shareholder, S election is automatically terminated
  • 38. Sale of Business Interest— Seller’s Issues (slide 3 of 3)
    • C Corp
      • Sale treated as sale of stock
        • Results in capital gain or loss to shareholder
      • No corporate level consequences
  • 39. Purchase of Business Interest—Buyer’s Issues (slide 1 of 3)
    • If the purchaser acquires an interest in one of these types of entities, he or she is treated as follows:
    • Sole Proprietorship
      • Purchaser is deemed to buy assets
        • Purchase price is allocated to assets
        • Assets are depreciated, amortized, etc...
  • 40. Purchase of Business Interest—Buyer’s Issues (slide 2 of 3)
    • Partnership
      • Purchaser buys partnership interest
      • Purchaser may ask partnership to make §754 election to step up inside basis in assets
  • 41. Purchase of Business Interest—Buyer’s Issues (slide 3 of 3)
    • S Corp or C Corp
      • Purchaser buys stock
      • There is no effect on underlying assets owned by the entity
  • 42. Tax Attributes of Different Business Forms (slide 1 of 19)
    • Maximum Max Tax Tax
    • # Owners Rate Paid By .
    • Sole Prop. One individual 35% Owner
    • Partnership At least two 35% Partner
    • (or LLC)
    • S Corp. Max = 100 35% Shareholder
    • Individuals, (Corp. may
    • estates, some have built-in
    • trusts only gains or PII tax)
  • 43. Tax Attributes of Different Business Forms (slide 2 of 19)
    • Maximum Max Tax Tax
    • # Owners Rate Paid By .
    • C Corp No max limit 35% corporate Corporation (some States level plus pays first, require at 15% max. then owner
    • least two on qualifying pays if
    • owners) distributions distribution
  • 44. Tax Attributes of Different Business Forms (slide 3 of 19)
    • Tax Year Timing of Income
    • Allowed Taxation Allocation .
    • Sole Prop. Owner’s yr. Owner’s N/A
    • yr. end (1 owner)
    • Partnership Majority or End of p/ship Profit/loss
    • LLC Principal tax year sharing ratio
    • Ptrs or “least Some special
    • aggregate allocations OK
    • deferral” year
  • 45. Tax Attributes of Different Business Forms (slide 4 of 19)
    • Tax Year Timing of Income
    • Allowed Taxation Allocation
    • S Corp. Calendar year or End of Corp Per share,
    • business purpose tax year per day
    • C Corp. No restrictions Corp reports at N/A
    • (generally) end of tax yr;
    • Shareholder reports
    • dividends received
  • 46. Tax Attributes of Different Business Forms (slide 5 of 19)
    • Contribution of Character of Income
    • Property to Entity Taxed to Owners .
    • Sole Prop. Not taxable Retains source
    • characteristics
    • Partnership Generally not Conduit-retains taxable source characteristics
  • 47. Tax Attributes of Different Business Forms (slide 6 of 19)
    • Contribution of Character of Income
    • Property to Entity Taxed to Owners .
    • S Corp. Taxable unless Conduit-retains source
    • meets §351 characteristics
    • C Corp. Taxable unless All source character-
    • meets §351 istics lost when income distributed to owners
  • 48. Tax Attributes of Different Business Forms (slide 7 of 19)
    • Loss Allocation Limitation on Loss
    • to Owners Deductible by Owners
    • Sole Prop. Not applicable Amount invested plus
    • liabilities of business
    • Partnership Profit and loss Ptr’s investment plus
    • sharing ratios share of partnership
    • liabilities
  • 49. Tax Attributes of Different Business Forms (slide 8 of 19)
    • Loss Allocation Limitation on Loss
    • to Owners Deductible by Owners
    • S Corp. Per share/ S/holder’s investment
    • per day plus loans from s/holder
    • to corporation
    • C Corp. Not applicable Not applicable
  • 50. Tax Attributes of Different Business Forms (slide 9 of 19)
    • At-risk Rules Passive Loss Rules
    • Applicable? Applicable? .
    • Sole Prop., Yes, at the Yes, at the
    • Partnership owner, partner owner, partner or
    • and S Corp. or shareholder shareholder level.
    • level. Indefinite Indefinite carryover
    • carryover of of unused losses
    • unused losses
  • 51. Tax Attributes of Different Business Forms (slide 10 of 19)
    • At- risk Rules Passive Loss Rules
    • Applicable? Applicable? .
    • C Corp. Yes, for closely held Yes, for closely held
    • corporations. Indefinite and personal service
    • carryover of unused corporations. losses. Indefinite carryover of unused losses.
  • 52. Tax Attributes of Different Business Forms (slide 11 of 19)
    • Capital Gains Capital Losses .
    • Sole Prop. Owner level Up to $3,000 against
    • 0/15% tax ord. income. Indefinite
    • carryover of excess.
    • Partnership Conduit-owners Conduit-owners
    • and S Corp. report shares same report shares same
    • as Sole Prop. as Sole Prop.
    • C Corp. Taxed at Corporate Carried back 3 yrs,
    • level up to 35 %. forward 5. Can only
    • offset capital gains.
  • 53. Tax Attributes of Different Business Forms (slide 12 of 19)
    • Consequence of Treatment of
    • Earnings Retained Nonliquidating
    • by Owners Distributions .
    • Sole Prop. Taxed when earned; Not taxable
    • increases investment in S.P.
    • Partnership Same as S.P. Not taxable unless
    • cash or liability relief > Ptrs. basis
  • 54. Tax Attributes of Different Business Forms (slide 13 of 19)
    • Consequence Treatment of
    • Of Earnings Retained Nonliquidating
    • by Owners Distributions .
    • S Corp. Same as S.P. Generally not taxable unless
    • distribution > AAA or stock
    • basis. May be dividend if
    • E & P from Sub C year.
    • C Corp. Taxed to corp. as Taxed in yr received up to
    • earned. Possible AE & P or if > stock basis.
    • AE Tax.
  • 55. Tax Attributes of Different Business Forms (slide 14 of 19)
    • Sale of Ownership Interest .
    • Sole Prop. Treated as a sale of each asset. Gain character depends on asset nature.
    • Partnership Treated as sale of underlying ordinary income assets. Remainder treated as sale of partnership interest (capital gain).
  • 56. Tax Attributes of Different Business Forms (slide 15 of 19)
    • Sale of Ownership Interest .
    • S Corporation Treated as sale of corporate stock
    • or C Corp. (capital gain). Loss may be ordinary if § 1244 applies, otherwise capital.
  • 57. Tax Attributes of Different Business Forms (slide 16 of 19)
    • Fringe Benefits §1244 Built-in
    • Avail. to Owners? Available? Gains effect?
    • Sole Prop. No No N/A
    • P’ship No No N/A
    • S Corp. Some if < 2% Yes Possible corp.
    • owner level tax
    • C Corp . Available Yes No effect
    • Limited by
    • anti-discrim.rules
  • 58. Tax Attributes of Different Business Forms (slide 17 of 19)
    • §1231 Gains Foreign Tax
    • and Losses Credits .
    • Sole Prop. Taxable or deductible Owner level
    • by owner. 5 yr.
    • lookback rule.
    • Partnerships Conduit—same Conduit—same
    • and S Corps as S.Prop. as S.Prop.
    • C Corp. Taxable/deductible Available
    • at corp. level 5 yr. Corporate level lookback rule
  • 59. Tax Attributes of Different Business Forms (slide 18 of 19)
    • Tax
    • Alternative ACE Preference
    • Min. Tax Adjustment Items .
    • Sole Prop. Applies at N/A Determined at
    • owner level owner level
    • (26% or 28%)
    • Partnership Applies at N/A Conduit—entity
    • or S Corp. ptr or preferences shareholder (26% or 28%) level pass thru to owners for their AMT calc.
  • 60. Tax Attributes of Different Business Forms (slide 19 of 19)
    • Tax
    • Alternative ACE Preference
    • Min. Tax Adjustment Items .
    • C Corp . Applies at Corp. 75% x (ACE Subject to
    • level (20%) -AMTI) is AMT at
    • added to AMTI corporate
    • (or subtracted) level
  • 61.
    • If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact:
    • Dr. Donald R. Trippeer, CPA
    • [email_address]
    • SUNY Oneonta