I am starting a new business. What type of legal entity should I use?
Choice of Legal Entity
Selecting a form of legal entity for a business can be a complex decision which is usually based on the type of business, the source of financing (present and future), the type of ownership, and the expected profitability of the business, among many other considerations. The following information should be used merely to familiarize yourself with the various choices and should not be used to select a form of entity without further consultation with counsel.
C-Corporation – This is the standard type of entity most widely used in the United States, and is used primarily by publicly held businesses and most large companies. The net income of a C-Corporation is taxed at the corporate level and losses are carried on the corporation’s books to be applied against future net income, with certain limitations. Shareholders in a C-Corporation are generally protected from any liabilities in excess of their investment. C-Corporations can have an unlimited number of shareholders and can have many classes of stock. Distributions to C-Corporation shareholders are not deductible to the corporation, but are generally taxable to the shareholder. C-Corporations can also select a year-end other than December 31st.
S-Corporation– This type of entity is used primarily by small, closely-held businesses. The net income of an S-Corporation is allocated to all shareholders based upon their ownership percentages and is taxed at the shareholder level (there are certain exceptions for state taxes). Likewise, the net losses are also allocated to shareholders and may be deducted at the individual level, with certain exceptions. Shareholders in an S-Corporation are generally protected from any liabilities in excess of their investment. S-Corporation may have no more than 100 shareholders, and those shareholders cannot be other corporations or non-resident aliens, among other limitations. S-Corporations can have only one class of stock and generally only have a calendar year-end (December 31st).
Partnership or Joint Venture – Partnerships may be either limited partnerships or general partnerships. Partners in a limited partnership are protected from liability in excess of their investment in the entity, whereas partners in a general partnership (and general partners in a limited partnership) have unlimited liability. Partnerships have no stock, and partners are taxed on their respective shares of net income or losses at the individual level. Partnerships have calendar year-ends and pay no Federal or State income taxes.
Limited Liability Company (“LLC”)– LLC’s may be treated as either a corporation or partnership. However, the vast number of LLCs are treated as partnerships. When treated as a corporation, the same general rules that apply to corporations apply. When treated as a partnership, the same general rules that apply to partnerships prevail, however, all LLC members are generally protected from liability. All LLCs are subject to an $800 annual tax. Additionally, the LLC may incur an additional fee that is based upon gross receipts of $250,000 or more. The additional fee can range between $900 and $11,790 in the State of California.
Business Trips That Mix Business with Pleasure
Many taxpayers plan trips that combine elements of both business and pleasure. Business trips, conventions, and continuing education seminars are frequently planned to incorporate exotic locations and leisure time. With proper planning, these trips can generate some legitimate deductions.
Taxpayers who travel away from their tax home on business are permitted to deduct travel expenses, including fares, meals, lodging, and incidental expenses, if they are not otherwise “lavish or extravagant”. A taxpayer’s tax home is his regular or principal place of business, or his residence if he has no regular or principal place of business. Naturally, you are not prohibited from enjoying non-business or personal activities while on a business trip, but the primary reason for the trip must be related to your trade or business.
Foreign travel expenses are subject to some limitations that are not applicable if the business trip is within the United States. Some of an individual’s foreign travel expenses may not be deductible if he or she takes part in substantial non-business activity during the trip. Taxpayers who travel outside the U.S. for longer than one week or spend less than 75 percent of their time on business are subject to allocation rules, which operate to partially disallow their expenses. The general rule is to allocate expenses, including meals and lodging, between business and non-business on a day-to-day basis. Each day is either entirely for business, or it is considered to be a non-business day. A day counts as entirely for business if the taxpayer’s principal activity on such day was the pursuit of a trade or business.
Expenses for both self-employed persons and employees to attend a convention in the U.S. may be deductible if there is a sufficient relationship to the taxpayer’s trade or business.
Cruise ships. A limited deduction (to a maximum of $2,000 annually) is permitted for conventions on cruise ships if the ship is of U.S. registry (most cruise ships are not registered in the U.S.), all ports of call are in the U.S. or its possessions, and the meeting is directly related to the taxpayer’s trade or business. Rigorous reporting requirements must be satisfied, including written statements by both the attendee and an officer of the sponsoring organization.
Foreign conventions.A foreign convention under the tax law is considered one held outside the U.S., its possessions, the Trust Territory of the Pacific Islands, Canada, or Mexico. The deductibility of expenses for foreign conventions is subject to a higher standard than for conventions held in the U.S. The taxpayer must establish that the meeting is directly related to the active conduct of his trade or business and that it is as reasonable to be held outside the North American area as within it.
For a stateside convention, the taxpayer merely has to show that his business duties and responsibilities are related to the agenda of the meeting even though it may not deal with the specific duties of the taxpayer’s work.
If you have any questions about how the travel rules would apply to any business trip that you anticipate taking soon, please contact us.
Using Living Trusts
A living trust is a fully revocable entity that you set up during your lifetime which holds your significant assets for your benefit. While you are living, you have full and complete access to your assets and the cash flow derived from those assets, as if the trust didn’t exist at all. At death the trust becomes irrevocable and its income and assets are disposed of under terms specified by you in the trust documents.
The main advantage of the living trust is that its assets are distributed without going through the time consuming and expensive process of probate, a legal proceeding that is supervised by the court system and various government agencies. The probate process is also a public proceeding where your personal financial affairs would be available to anyone who inquires. Even with a living trust, there are expenses associated with the preparation of an estate tax return, valuation and transferring assets, and making a formal accounting and settlement.
Some additional factors to consider are:
- Quicker distributions: Probating a will and gathering assets into the estate for distribution can take quite a bit of time. With a living trust, by contrast, all assets already are gathered together, so the trustee can make immediate distributions and continue paying bills as usual.
- Protecting minors: Living trusts can help avoid the need to appoint a guardian to represent children’s interests, which can cause delay and add to administration costs.
- Multiple residences: Those with real estate in more than one state can avoid the problems and expense of multiple probate proceedings by putting the out-of-state real estate in a living trust.
- Income taxes: If you create a living trust, you will be taxed on its income in the same way as if you continued to own the property outright.
- Estate taxes: If you are married, proper estate planning can also result in significant estate tax savings. Each individual has a personal unified credit that is available, whereby a certain amount of net assets (currently $3.5 million) may be passed on to persons, other than your spouse, free of estate taxes. If your joint estate is larger than the unified credit amount, the basic strategy is to preserve each spouse’s unified credit by placing assets in the amount of the credit into a separate trust that is not specifically earmarked for the surviving spouse.
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Estate planning techniques can be quite complex and the above discussion is, by no means, intended to be complete. If you currently do not have an estate plan and wish to begin the planning process, please contact us to discuss your situation.
How Long Should I Keep Old Records?
|Accident reports||7 years|
|Accounts payable and receivable records||7 years|
|Bank reconciliations||2 years|
|Bank statements||7 years|
|Capital stocks Permanent Cancelled checks (for important transactions)||Permanent|
|Contracts and leases (expired)||7 years|
|Contracts and leases (in effect)||Permanent|
|Deeds, mortgages, and bills of sale||Permanent|
|Employment records (as employer)||7 years|
|Employment records (as employee) after termination||1 year|
|Insurance policies (after expiration)||1 year|
|Insurance claim records||Permanent|
|Invoices to customers/from vendors||7 years|
|IRA, Keough, and other retirement plan data||Permanent|
|Minute books and other corporate records||Permanent|
|Payroll records||7 years|
|Tax return back-up documentation||7 years|
I want to buy a new home. How much will it cost me?
Use our Loan Calculator to find out the possible payments.
Should I buy or lease my car?
Advantages of Leasing: (The following advantages of leasing apply primarily if you use your automobile for more than 50% of your total miles driven for business purposes. This generally excludes ‘commuting’ to and from your primary place of business):
- Deductibility of most of the monthly lease payment (this is especially good for expensive cars)
- Lower up-front payment is required
- No need to ‘sell’ or ‘trade-in’ the car at lease termination
Disadvantages of Leasing:
- All leases come with mileage restrictions which, if exceeded, can be costly
- It is generally very expensive to terminate a lease before the original lease term is complete
- Leasing is generally more costly than buying
- During the lease term, there is no equity in your vehicle.
- At the end of the lease, the purchase option is generally not desirable as the contractual purchase price may be higher that the automobile’s market value.
Advantages of Buying:
- You generally have some equity in your vehicle and, if necessary, you could sell it and have money available after paying off your loan
- You can sell you car at any time
- There are no mileage restrictions, but excess mileage may affect you car’s value
Disadvantages of Buying:
- You are usually required to pay a larger down payment when buying a vehicle
- Your tax deduction may be severely limited for your business use, depending upon the value of the automobile. Restrictions begin for automobiles priced over $14,800, withstanding possible bonus depreciation. (These restrictions do not apply to alternative fuel vehicles and vehicles weighing more than 6,000 pounds)
- You are faced with the prospect of having to sell you car privately (and dealing with potential buyers) or trading your car into a dealer, usually at a value far below market value