CD ROM Paradise Collection 4/CD ROM Paradise Collection 4 1995 Nov.iso/business/sba952.zip/F113.SBE

Text File | 1995-05-31 | 5KB | 102 lines

@071 CHAP 2

         ┌─────────────────────────────────────────────┐
         │   CHOICE OF ENTITY:  PROFESSIONAL SERVICE   │
         │      BUSINESSES AND SIMILAR OPERATIONS      │
         └─────────────────────────────────────────────┘

Traditionally, C corporations (professional service corpor-
ations) have been the legal vehicle of choice for most
providers of professional services, as well as some enter-
tainers and professional athletes.  This was primarily to
take advantage of qualified pension and profit sharing
plans, tax deductible fringe benefits (medical insurance,
etc.), income deferral from using a fiscal tax year and low
tax rates on net income retained by the corporation.  Even
professional partnerships were often structured so that the
partners in the partnership were mostly or entirely profes-
sional corporations set up by the individual professionals
(primarily to take advantage of certain provisions of the
tax laws regarding pension plans).

Most of these excellent reasons for operating as C corpora-
tions began to disappear in 1982.  Since 1984, Keogh and S
corporation pension and profit sharing plans have been
given virtual "parity" with C corporation plans; the 1986
Act did away with fiscal years for most new personal ser-
vice corporations and virtually prohibited the use of sep-
arate pension plans for each corporate partner in a part-
nership; and the Revenue Act of 1987 did away with gradu-
ated tax rates for "qualified personal service corpora-
tions," thus subjecting ALL taxable income of such corpor-
ations to a flat rate tax of 34% (35% after 1992).  (Of
course, not all kinds of service businesses are subject
to each of the above new restrictions on personal service
corporations, since the definitions vary slightly in each
instance.)

In addition, all C corporations are now subject to eventual
double taxation on appreciated corporate assets when such
corporations are eventually liquidated, and are potentially
subject each year to alternative minimum tax where "adjusted
current earnings" differ from regular taxable income for var-
ious corporate income and deduction items.  Those corpora-
tions subject to the 35% flat tax rate must now also be very
careful in paying out enough salary each year to zero out
taxable income, to avoid paying this high tax rate.

Also, where a new business is expected to operate at a loss
for a year or more, such losses must be carried forward by
a C corporation (for 15 years) until the corporation gen-
erates enough income to use up the losses, or the carry-
overs expire.  For an unincorporated service business or
one operating as an S corporation, these early losses may
be used by the individual owners immediately to offset
their other income of any kind.   (These would not ordin-
arily be considered passive losses.)  Note, however, that
for shareholders of an S corporation to utilize losses,
their losses may be claimed on their individual tax returns
only to the extent of their tax basis in their S corpora-
tion stock, plus the amount of any loans they have made
directly to the S corporation (simply agreeing to guarantee
a loan made to the corporation by a lender will NOT give
the shareholder any tax basis).

Personal service corporations that are C corporations still
enjoy an advantage over S corporations and unincorporated
businesses with regard to deductibility of fringe benefits
for employee-owners, though.  However, the rules prohibit-
ing discrimination against rank-and-file employees in cov-
erage and benefits under these benefit plans have gradually
been tightened in recent years.

While it is not possible to make any blanket recommendation
as to the legal form a new personal service business should
adopt, most advisers today seem to agree that the typical
professional service corporation should probably avoid C
corporation status and should strongly consider becoming an
S corporation or remaining unincorporated, instead.  The
deck has simply become too heavily stacked against most
kinds of personal service corporations (other than S cor-
porations).  Where limited liability is important, an S
corporation will now often be preferable to operating as a
proprietorship or partnership.  Note that in virtually all
states, a "professional corporation" (medical, law, accoun-
tancy, etc.) does NOT confer limited liability on its share-
holders for purposes of malpractice claims, however.

@IF173xx]Since your firm operates in a professional service business,
@IF173xx]it is probable that a professional corporation wouldn't pro-
@IF173xx]vide limited liability for @NAME.

@IF175xx]PLANNING POINT FOR YOUR FIRM, @NAME:
@IF175xx]┌───────────────────────────────────────────────────────────┐
@IF175xx]│Because your firm's business is consulting, however, rather│
@IF175xx]│than being in a "profession" such as law of medicine, you  │
@IF175xx]│should be able to obtain limited liability by operating the│
@IF175xx]│business in corporate form, without being a "professional  │
@IF175xx]│corporation."                                              │
@IF175xx]└───────────────────────────────────────────────────────────┘