Monster Media 1996 #14/Monster Media No. 14 (April 1996) (Monster Media, Inc.).ISO/business/sba961.zip/F113.SBE

Text File | 1996-01-01 | 6KB | 117 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 35%.  (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 (or as a "limited liabil-
ity company" or "limited liability partnership," in certain
states), these early losses may be used by the individual
owners immediately to offset their other income of any kind.
(These would not ordinarily be considered passive losses.)
Note, however, that for shareholders of an S corporation to
utilize losses, their losses may be claimed on their indi-
vidual tax returns only to the extent of their tax basis in
their S corporation stock, plus the amount of any loans
they have made directly to the S corporation (simply agree-
ing 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.

A number of states now allow professionals to operate their
practices in the form of a limited liability company ("LLC").
LLC laws have been enacted in all but 3 states.  However,
many such states don't allow professionals to use the LLC
form -- but a number of those states allow a similar type of
organization called a "limited liability partnership," or LLP.
In states where professionals can operate in LLC or LLP for-
mat, they will benefit from some reduction in personal liabil-
ity, but only to the same limited extent as a professional
corporation; that is, practitioners will still be personally
liable for their own acts of professional malpractice.  An LLP
or LLC for a professional is treated like a partnership for
tax purposes (with the same advantages and disadvantages, as
compared with a C corporation), but with the added benefit of
SOME reduction of personal liability exposure, which is not
provided by a partnership.

@IF173xx]Since your firm operates in a professional service business,
@IF173xx]it is probable that a professional corporation (or LLC) won't
@IF173xx]provide 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]└───────────────────────────────────────────────────────────┘