Taxation and Corporations
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- A joint stock company
- Insurance company
- Bank, if insured by the FDIC
- Business entity wholly owned by a state or any political
subdivision thereof
- Certain foreign business entities
Many business owners look to incorporate in the hopes of
protecting themselves and limiting their liability. When clients
come in and ask about this, I let them know as clearly as possible
that this is not always the case.
The general rule of liability is that a corporation formed under state
law can shield owners from liability for the corporation's actions.
All that you have at risk is the amount of stock you have invested
in the corporation. This can, in fact, limit your liability, but not
always. In recent court rulings there is a trend in piercing the
corporate veil regarding small business corporations.
In recent court cases this limited liability status has been
disregarded for shareholders of corporations demonstrating of bad
faith (i.e., failure to observe corporate formalities and/or negligent
business practices causing injury). In addition, a shareholder who
owns 100% of stock in a corporation is particularly susceptible. If
you are the only stockholder it is in your best interest to get good
advice about incorporating.
If it turns out that incorporating is a good option for you, and you
decide to take this path, you will then need to decide if election of
S status is right for your corporation. The primary benefit of this
status is that the corporation is not taxed at the corporate level.
The profits and losses are passed through directly to the
shareholder then taxed at the individual shareholder level, thus
avoiding the double taxation found with C corporations.
Electing for S status of your corporation can be beneficial in the
early years of your business because losses are passed through to
shareholders and deducted on their personal return - unlike a loss
in a C corporation. A loss in a C corporation has to be carried back
3 years and forward up to 15 years and is only deductible on the C
corporation's profits, not the individual shareholders other income.
S corporations' requirements:
- All shareholders must consent to S corporation status
- Limited to 75 shareholders (husband and wife are treated as one
shareholder)
- Only one class of stock permitted
- The corporation must be domestic and all shareholders must be
citizens or residents of the United States
- Generally, the corporations must use a calendar year
- Only individuals, estate, certain trusts and certain charities may
be shareholders
- Generally, other corporations, partnerships and IRAs are ineligible
to be a share holder in an S corporation.
The Tax Act of 2003 changed the rate for individuals on dividends.
Now individuals are taxed on most of their dividends at the same
rate as long-term capital gains. This has reduced the negative
effects of double taxation at the C corporation level. One has to
consider that as S corporation profit is passed through to
shareholders and is taxed as ordinary income. Again, we remind
you to come into the office to discuss this. Your marginal tax rate
is an important factor when determining the best tax treatment and
the best corporate structure for you.
It has always been my policy to advise my clients as to what is
most advantageous for them. It is my job to keep abreast of the
changes in tax code and be able to provide you with the latest
information. I work for you in tax planning so that you to be able
to keep more money in your household and still remain in
compliance with the current tax law.
