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1992-12-01
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@Q01
┌───────────────────────────────────────────┐
│ TO INCORPORATE OR NOT TO INCORPORATE: │
│ THE PERENNIAL QUESTION │
└───────────────────────────────────────────┘
Please enter the name of your business (or your proposed
business):
@TX
01\Q02
@Q02
QUESTION: Is this a business that you have already started
(or acquired)?
@YN
01\Q03
02\Q10
@Q03
QUESTION: If you were to sell your business (or the stock
of your incorporated business) today for its fair
value, how much of a taxable gain or a loss would
you have on the sale? (Make your best guess.)
. 1 - A gain of over $1 million
. 2 - A gain of $500,000 to $1 million
. 3 - A gain of $100,000 to $500,000
. 4 - A gain of $50,000 to $100,000
. 5 - A gain of about $0 to $50,000
. 6 - Breakeven, more or less
. 7 - A loss of less than $50,000
. 8 - A loss of $50,000 to $150,000
. 9 - A loss in excess of $150,000
@MC\09
01\Q04
02\Q04
03\Q04
04\Q04
05\Q04
06\Q04
07\Q04
08\Q04
09\Q04
@Q04
QUESTION: Is the business in question already incorporated?
@YN
01\Q05
02\Q10
@Q05
QUESTION: Is the corporation an "S corporation"?
@YN
01\Q06
02\Q22
@Q22
NET OPERATING LOSS OR TAX CREDIT CARRYOVERS: A C corporation
that incurs net operating losses or has more tax credits than
it can use in the current tax year can generally carry the
losses or unused tax credits back to any of its 3 preceding
tax years, to obtain refunds of taxes paid in those years.
However, for a new corporation, or one that has no profitable
prior years to carry losses or credits back to, there is no
other choice but to carry the net operating losses (NOL's) or
credits over to future years, in the hope that it will even-
tually have taxable income against which the NOL or credit
carryovers can be offset, reducing taxes in those future
years. (Most NOL's or unused tax credits can be carried for-
ward for up to 15 tax years after the year incurred.)
QUESTION: Does your C corporation have substantial unused
net operating loss or tax credit carryovers at
present?
@YN
01\Q06
02\Q06
@Q06
TAX LOSSES: Start up losses incurred by a regular ("C") cor-
poration cannot be passed through to shareholders, but must
be carried forward until (if ever) they can be used to off-
set future taxable income of the corporation....And a more-
than-50% change in stock ownership of the corporation can
severely reduce the corporation's right to use a large part
of any such tax loss carryovers.
An S corporation election can be very useful in the early sta-
ges of a business if it is losing money, due to the fact that
the losses an S corporation incurs can be "passed through" to
its shareholders and, in many cases, deducted on their indiv-
idual tax returns. An S corporation can also pass through cer-
tain tax credits, such as the targeted jobs credit and various
other business credits, which might not be utilized currently
in a C corporation that has little or no net taxable income.
QUESTION: Is your corporation generating tax losses (Or do
you expect it to?) in amounts you consider substantial?
@YN
01\Q21
02\Q07
@Q21
The usability of your corporation's tax losses, even if it is
an S corporation, depends upon whether those losses (and/or
tax credits) can be passed through and utilized by the stock-
holders. Thus, such losses may not flow through to your indi-
vidual tax return if, for instance, they are "passive activi-
ty" losses; you or the S corporation are not considered "at-
risk" with respect to the losses; or you lack sufficient "tax
basis" in your S corporation stock to utilize any further
losses. Or, even if the losses or credits flow through to
your individual return, you may not be able to use them cur-
rently, due to insufficient taxable income of your own in the
current year (or preceding 3 years) against which the losses
can be applied, or else credits may not be usable by you due
to such factors as the alternative minimum tax (AMT).
QUESTION: To the best of your knowledge (only your tax
adviser can tell you for sure about this one),
do you think you could utilize your corpora-
tion's tax losses if it is an S corporation?
@YN
01\Q12
02\Q12
@Q07
QUESTION: How much annual PRE-TAX profit do you expect the
corporation to earn each year in the near future
(assuming you limit owner salaries to no more
than $100,000 a year per owner, as a maximum) ?
. 1 - None: We expect to have losses, or very
minimal net profits, under $10,000 (as
defined above)
. 2 - Between $10,000 and $100,000 profit (as
defined above)
. 3 - Between $100,000 and $335,000 profit (as
defined above)
. 4 - Over $335,000 pre-tax profit (as defined
above)
@MC\04
01\Q12
02\Q12
03\Q12
04\Q12
@Q10
TAX LOSSES: Start-up or other losses or tax credits earned
by an unincorporated business (a sole proprietorship or part-
nership) can generally be passed through to the owner or ow-
ners, to be claimed on their individual income tax returns.
(Unless the deductions or credits are suspended due to at-
risk or passive activity loss rules, or on account of insuf-
ficient tax basis.) Such losses or credits cannot be used
if the legal form of the business is a C corporation, but
must instead be carried over to another year in which the
corporation has taxable income.
QUESTION: Will your business generate tax losses or tax
credits in the next tax year (or two), in
amounts that you consider substantial?
@YN
01\Q12
02\Q11
@Q11
QUESTION: How much pre-tax profit (per owner, if more
than one owner) do you expect the business to
earn, on average, for the next few years
(assuming the business is not incorporated)?
. 1 - None: We expect to have losses, or not
over $50,000 profit (as defined above)
. 2 - Between $50,000 and $100,000 profit (as
defined above)
. 3 - Between $100,000 and $335,000 profit (as
defined above)
. 4 - Over $335,000 pre-tax profit (as defined
above)
@MC\04
01\Q12
02\Q12
03\Q12
04\Q12
@Q12
Medical insurance, medical reimbursement plan expenses, and
other "fringe benefits" such as disability insurance and
group-term life insurance are generally not deductible expen-
ses for owners of unincorporated business or shareholders
(owning 2% of the stock or more) of S corporations. By con-
trast, a C corporation that pays for such benefits for its
employees, including owner-employees, is generally able to
deduct such expenses, with the value of such coverage gener-
ally NOT being taxable to the employees (except for the
value of group-term life insurance coverage in excess of
$50,000 for a given employee).
QUESTION: Do you (or does your business) plan to purchase
medical coverage, disability insurance or group-
term life insurance for you or the other owners
of the business?
@YN
01\Q20
02\Q20
@Q20
DIVIDENDS-RECEIVED DEDUCTION. A C corporation may sometimes
be used advantageously to hold dividend-paying stocks, since
the federal tax law allows the corporation to avoid paying
tax on 70% of the dividends it receives (80% if your company
owns 20% or more of the stock of the company paying the divi-
dends). This deduction is NOT allowed to an S corporation
that gets dividends. Putting securities in your corporation
is not always a wise idea, however, despite the 70% dividends-
received deduction. Taking the stocks (or proceeds from their
sale) back out of your corporation can result in taxable gains
at the corporate level and dividend or taxable gain to you as
a shareholder, to the extent of the value of whatever you take
out of the corporation. Thus, it can be costly if the situa-
tion changes and you take the stock back out of the corporation.
QUESTION: If you have significant dividend income from stocks,
and in light of the foregoing discussion, would you be
likely to benefit from the dividends-received deduction
if your business, as a C corporation, held stocks?
@YN
01\Q13
02\Q13
@Q13
QUALIFIED PERSONAL SERVICE CORPORATIONS: Certain personal
service businesses, if incorporated and engaged in rendering
services in certain fields such as law, health, accounting,
actuarial sciences, architecture, engineering, performing
arts or consulting, are considered "QUALIFIED personal ser-
vice corporations." ("QPSC") (If substantially all the stock
is owned by employees or retired employees, etc.) Note that
this definition is slightly different from the definition of
"PERSONAL SERVICE CORPORATIONS" that applies to determine a
corporation's permissible tax year & tax accounting method.
A "QPSC" is taxed at a higher tax rate, generally (34% flat
rate), than other C corporations (whose tax rates start at
15%). Obviously, this is a major disadvantage of being a QPSC.
QUESTION: To the best of your knowledge (we realize this is
a VERY technical definition), is your business one that
will be considered a QPSC, if operated as a corporation?
@YN
01\Q14
02\Q14
@Q14
PENSION PLANS: Both incorporated and unincorporated busines-
ses may maintain qualified pension or profit-sharing plans,
and the limits on contributions, benefits, etc., are now
roughly the same for corporate, Sub S and Keogh (noncorpor-
ate) retirement plans. There are a few differences that re-
main, however, despite the "parity" rules that generally put
corporate and noncorporate plans on an equal footing in 1984.
QUESTION: Does (or will) your business maintain qualified
pension and/or profit-sharing plans for the
owners and employees?
@YN
01\Q15
01\Q16
@Q15
BORROWING FROM YOUR PENSION PLAN: The tax law allows a par-
ticipant in a qualified pension or profit sharing plan, in
some cases, to borrow against his or her account in the pen-
sion or profit sharing plan, up to as much as $50,000 in
some cases. But such borrowing is effectively prohibited
in the case of certain types of qualified pension or profit
sharing plans.
QUESTION: How important, on a scale of 1 to 5 (with 5 being
most important, 1 being least), is the ability to
borrow from your company's pension plan to you
(or to your co-owners in the business)?
@MC\05
01\Q16
02\Q16
03\Q16
04\Q16
05\Q16
@Q16
LIMITED LIABILITY. One reason many businesses incorporate is
to limit the liability of the owners, in the event the busi-
ness fails. However, for most small businesses, lenders will
usually require that the shareholders of a corporation person-
ally guarantee repayment of any loans made to the corporation,
since the lender is looking primarily to the owners, rather
than the assets of the corporation itself, for security.
Thus, for many types of liabilities typically incurred by a
small or medium-sized business, incorporation will not serve
to limit the owners' liability if the business bellies up--
except against unsecured creditors, such as vendors who have
extended credit to the business.
QUESTION: How important to your business is the ability
to limit liability by incorporating (on a scale
from 1 to 5, with 5 being VERY important)?
@MC\05
01\Q17
02\Q17
03\Q17
04\Q17
05\Q17
@Q17
PERSONAL HOLDING COMPANY STATUS: If your business derives 60%
or more of its "adjusted ordinary gross income" from certain
types of income, such as rents, royalties, interest or divid-
ends, and operates as a C corporation, any net income that it
fails to distribute as dividends to its shareholders may be
subject to federal "personal holding company tax" of 28%, at
the corporate level. This penalty tax does NOT apply to an
unincorporated business or to an S corporation; nor to a C
corporation unless over 50% of the stock is held (directly or
indirectly) by five or fewer people. (A company with 50% or
more of its "ordinary gross income" from a single passive cat-
egory, such as rents, mineral/oil/gas royalties, copyright
royalties, produced film rents, or active business computer
software royalties, MAY be able to avoid personal holding com-
pany status if various other technical requirements are met.)
QUESTION: Based on the brief description above, do you be-
lieve your business will be a "Personal Holding
Company" if operated as a C corporation?
@YN
01\Q18
02\Q18
@Q18
_______________________________________________________________________
@BR\18
01\Q19
@Q19
@STOP
@RD\01
RECOMMENDATIONS: Based on your responses to the foregoing
questions, the "EXPERT" has come to a tentative conclusion
as to which legal form of business appears most advisable
in your particular situation. (See below.)
CAUTION: The following recommendation has been arrived at
by weighing and assigning points to various known factors
regarding your business, in an algorithm that attempts to
quantify the unquantifiable. Since there are always numer-
ous pros and cons in evaluating the optimum choice of legal
entity, the process used by the program is a lot like com-
paring 3 oranges with 2 apples and concluding which is
better.
Accordingly, you should not regard the following recommenda-
tion as a definitive judgment, since it involves some very
subjective choices and conclusions by the author of the pro-
gram, and is also based on far less than complete informa-
tion about your situation. However, it does represent an
serious attempt to model the thought processes the author,
an attorney and CPA, would go through in advising a client
as to choice of legal entity, based on the key facts just
elicited from you. Just remember that, in making "fuzzy"
decisions of this type, no computer program is an adequate
substitute for the considered judgment of a competent, ex-
perienced, and intuitive professional adviser with a full
grasp of the facts and circumstances relating to you and
your business.
RECOMMENDATION AS TO FORM OF BUSINESS:
|VAR|
@RD\02
RECOMMENDATIONS: Based on your responses to the foregoing
question and answer session, the program is unable to ident-
ify any clear "Best" choice of legal entity for your busi-
ness. While various weightings have been given to each of
the three basic entity choices (unincorporated entity, C
corporation and S corporation), and points assigned to each
alternative, based on the largely subjective rating system
devised for this program, there does not appear to be any
clearly preferable entity choice in this case.
However, for your consideration, we have provided the scores
developed in our internal system of analysis. These numbers
have no real meaning, and essentially represent an attempt
to quantify our "hunches" about the optimum legal entity for
your situation, based on the limited data we have on your
business.
(Note that there is |VAR| difference in the scores we
developed, for the first- and second-best choices. Since
there is a considerable lack of precision in our "fuzzy
logic" methodology on which these scores are based, this
one is definitely too close to call.)
@RD\03
More useful, in our opinion, will be your consideration of
the various pros and cons of incorporation vs. not, C cor-
poration vs. S corporation, etc., which are listed below,
all of which are derived from our analysis of what you have
told us about your particular company.
@RD\04
. Operating in unincorporated form is, to begin with, of-
ten much simpler and less costly administratively than
operating your business as an incorporated entity.
@RD\05
And, as you have probably already learned from experi-
ence, operating as an S corporation is even more compli-
cated than as a regular C corporation, due to the com-
plexity of the tax laws governing S corporations and the
need for expert accounting and tax help to maintain the
S corporation properly.
@RD\06
. Since your business expects to incur substantial operat-
ing losses for awhile, being unincorporated would give
you a better chance to derive some current tax benefit
from those losses, providing you (or your co-owners, if
any) can personally utilize the losses or tax credits
generated. As a C corporation, by contrast, any such
losses (or tax credits) as are generated could not be
utilized currently (by either the corporation or you),
|VAR|.
(An S corporation, of course, could generally pass
through any such operating losses to the owner(s), much
the same as an unincorporated business.)
@RD\07
. From the responses you have given, it appears that it
could be advisable to consider liquidating your corpora-
tion, and recognizing a substantial tax loss on the li-
quidation of your stock. Of course, if the loss is
treated as a capital loss, you will only be able to de-
duct $3,000 a year against your other income (unless you
have capital gains the loss could offset). However, if
your stock is eligible for "Section 1244 Stock" treat-
ment, you may be able to treat the first $50,000 (or
$100,000 on a joint return) of any loss on liquidation
as an ORDINARY loss, which ought to be fully deductible
in many cases. (There are a number of technical quali-
fications in order to actually take such a loss, so con-
sult a good tax lawyer or other competent tax adviser
before concluding that you ought to liquidate your cor-
poration, |VAR|.)
@RD\08
. You may want to liquidate your C corporation and operate
as a sole proprietorship or partnership, or else elect S
corporation status, in order to avoid high marginal cor-
poration tax rates, which it appears in this case would be
|VAR| (Federal), compared to marginal tax rates of about 31
to 33% if the business income were taxed at individual in-
come tax rates, rather than C corporation rates. (However,
there might be significant taxes to recognize, by the cor-
poration upon any such liquidation, so electing S corpora-
tion status may be a better tactic.)
@RD\09
. It appears that at your company's level of profitability,
a C corporation would probably be in a marginal income
tax bracket of |VAR|. Thus an unincorporated business
would probably save some current federal income taxes,
since individuals are taxed at federal income tax rates
of no more than about 31% to 33%, as a general rule.
@RD\10
. An unincorporated business will also save on Federal and
state unemployment taxes on the earnings of the owners,
since as owner-employees of a corporation, unemployment
taxes would apply to wages or salary paid to the owner--
but no such tax applies to the business earnings of a
partner in a partnership or to a sole proprietor, who
take a "draw" rather than salary or wages.
. Unincorporated businesses do not have to be concerned with
the possible double taxation of profits, unlike C corpora-
tions (and, to a lesser extent, some S corporations).
. An unincorporated business does not have to be concerned
with either of the corporate penalty taxes, the personal
holding company tax or the accumulated earnings tax, both
of which apply only to C corporations.
@RD\11
. One other important benefit of starting out a business in
unincorporated form is increased flexibility, from a tax
standpoint. An unincorporated business can always incor-
porate, but if you have already incorporated, liquidating
in order to dis-incorporate can give rise to potentially
huge capital gains taxes.
@RD\12
. Operating as a C corporation can be a real drawback in the
case of your business, since you have indicated that your
particular type of business is one that may be considered
a Personal Holding Company. If so, and you are unable to
zero out its income each year through salary payments or
other operating expenses, you could be in the grim situa-
tion of incurring double taxation on the corporation's
net income. That is, not only would the corporation pay
tax on its pre-tax income, but there would also be a se-
cond tax on the remaining after-tax net income: either
the 28% personal holding company tax, or, if all of the
after-tax net income is paid out as dividends to the
shareholders, individual income tax on the dividend pay-
ments. This is not a problem if you operate the business
in unincorporated form, or as an S corporation.
@RD\13
. Perhaps the most common and pervasive reason for a busi-
ness to be incorporated is to achieve some degree of lim-
ited liability. While such limited liability may not be
absolute, particularly where creditors of the corpora-
tion, lessors, etc., require the owners of the corpora-
tion to personally guarantee repayment of corporate loans
or leases, limited liability can still be a big advantage.
@RD\14
You have indicated that limited liability is VERY import-
ant for |VAR|.
@RD\15
You indicated, however, that limited liability is NOT very
important for |VAR|.
@RD\16
. Liquidating a corporation where there is a taxable gain
on the transaction can be costly, particularly since it
is often difficult to determine the fair value of a going
concern (and since the IRS may argue that your taxable
gain is much larger than you thought it was). Since you
have indicated that you would probably have a substantial
gain on liquidation of your existing corporation, the re-
sulting tax liability you would personally incur is one
good reason NOT to dis-incorporate by liquidating. Also,
the corporation itself may incur additional tax upon any
liquidation if it holds assets (including intangibles
like "goodwill" that may not even be on its books) that
have a value in excess of their tax basis.
@RD\17
. Because you have indicated your business is incurring
operating losses, an S corporation would have advantages
for you, as compared to a C corporation, since some or
all of such corporate tax losses may be "passed through"
to you as a shareholders, and thus should be currently
utilizable by you in reducing your personal income tax
liability. By contrast, start up losses incurred by a
corporation cannot be used to offset income, unless car-
ried over and used to reduce the corporation's taxable
income in future years, when (or if) the corporation ev-
entually becomes profitable. A deduction today is usu-
ally worth more than a possible deduction some years in
the future.
@RD\18
. For a business operating at an annual profit level of
less than $100,000 or so (after owners' salaries), a C
corporation may provide an income-splitting opportunity
which can reduce, or at least defer, overall taxes.
This can be done by leaving some profit (under $75,000
a year, preferably) in the C corporation, shifting such
income out of the owners' 28% or 31% tax brackets into
the lower corporate tax brackets of 15% on the first
$50,000 and 25% on the next $25,000 of corporate taxable
income. This won't work if the corporation is a "qual-
ified personal service corporation," which is subject
to tax at a flat rate of 34% on all its net income. But
you have indicated that the business may have profits
of less than $100,000 a year, and that it will not be
considered a "qualified personal service corporation"
if operated as a C corporation, so you may be able to
benefit to some extent from income-splitting by using
|VAR| as a second taxpayer.
@RD\19
. Unlike a sole proprietorship or partnership, a corpora-
tion has continuous existence and does not terminate
upon the death of a stockholder or a change of ownership
of some or all of its stock. Creditors, suppliers, and
customers often prefer to deal with an incorporated busi-
ness because of this greater continuity of the enterprise
that is provided by the corporate form. Of course, like
other forms of business organization, a corporation can
be terminated by mutual consent of the owners, or even
by one shareholder in some instances.
. A corporation also provides advantages, particularly when
compared to a partnership, of centralized control, since
state corporate laws typically provide rules for election
of a board of directors by the shareholders and selection
of a president and other corporate officers to manage the
everyday affairs of the business, by the board of direc-
tors. Lines of authority are usually much clearer and
more formal than in the usual partnership arrangement.
@RD\20
. The ability of participants to individually borrow
against their accounts under a pension plan can be a sig-
nificant benefit of having a pension plan for your em-
ployees. However, borrowing is allowed only in the case
of a "qualified" pension or profit sharing plan of a C
corporation. Such borrowing is subject to a "prohibited
transactions" penalty tax in the case of a plan main-
tained by unincorporated business (Keogh plan) or by an
S corporation. You have indicated that the ability of
the participants to borrow from your company's pension
or profit sharing plan is|VAR| important to you.
@RD\21
. The corporate "dividends-received deduction," under
which a C corporation (but not an S corporation) can
exclude 70% or more of dividends it receives from cor-
porate stock investments from taxable income, is a val-
uable potential tax benefit of operating a business in
the form of a C corporation. You have indicated that
this may be an important tax benefit in your case.
@RD\22
. The federal tax laws permit corporate employers (except
for S corporations) to provide a number of different
fringe benefits to employees who are owners (shareholder-
employees), on a tax-favored basis. Generally, the emp-
loyer is allowed to deduct the insurance premiums or oth-
er payments it makes on behalf of the employee, while
the employee is not taxed on the value of the benefit
provided. Thus, being incorporated (as a C corporation)
has important advantages for your business if you wish
to obtain group-term life insurance, health/accident
coverage (insured or otherwise), or disability insurance
coverage for the principals in your business, since you
will not be able to obtain this favorable tax treatment
as an S corporation, or as a partner or sole proprietor
in an unincorporated business, with regard to these
kinds of fringe benefit plans.
@RD\23
. Because your C corporation has substantial unused net op-
erating loss (NOL) or tax credit carryovers, liquidating
the corporation would have a major disadvantage: Those
NOL or credit carryovers, which might otherwise be used
to offset future taxable income of the corporation some-
day, would vanish forever if your corporation were li-
quidated and turned into an unincorporated business.
Also, if S corporation status were elected, those carry-
overs would then become useless until after the corpora-
tion elected to revert back to C corporation status once
again--they cannot be used to shelter any income earned
while operating as an S corporation.
@RD\24
. You have indicated that your business is a professional
service firm. As a C corporation, you will incur a ma-
jor disadvantage, since all of the taxable income of a
"qualified professional service corporation" is subject
to a flat federal tax rate of 34%. This is higher than
the top individual tax bracket and a serious disincen-
tive to operating a professional firm as a C corporation.
@RD\25
_______________________________________________________________________
S CORPORATIONS VS. C CORPORATIONS:
Advantages of C Corporations over S Corporations--
. C corporations are generally less complex entities to
maintain, from a tax standpoint, than S corporations.
. C corporations (except for certain "personal service cor-
porations"), can offset losses from passive activities
against active business income. S corporations cannot.
. C corporations are entitled to the dividends received de-
duction on any dividend income they receive; S corpora-
tions are not.
@RD\26
. C corporations are separate tax-paying entities, so at
certain levels of corporate net income, generally under
$100,000, a C corporation may be used advantageously to
split income, paying tax at rates lower than if the in-
come were all taxed to individual shareholders, as in
the case of an S corporation.
@RD\27
. Shareholder-employees of C corporations have advantages
over S corporation shareholders (who own over 2% of the
stock) with regard to excluding from income the cost of
certain fringe benefits for owners, such as health care
coverage, group-term life insurance, and long-term dis-
ability insurance.
@RD\28
. Owner-employees may borrow from their qualified pension
or profit sharing plans, if the plans are sponsored by
a C corporation.
@RD\29
Advantages of S Corporations over C Corporations--
. S corporations do not usually have to be concerned about
possible double taxation of corporate profits, since
their profits are generally taxed only once, to their
shareholders.
. Also, S corporations are not subject to corporate penal-
ty taxes, such as the personal holding company tax or
the accumulated earnings tax, which apply only to C
corporations.
@RD\30
. If a new corporation is incurring losses, shareholders
of an S corporation may be able to utilize the tax los-
ses currently, while a C corporation can only carry the
losses over till it eventually (if ever) becomes profi-
table.
@RD\31
. Conversely, at high levels of taxable income (generally
over $100,000), S corporation shareholders may pay tax
at a lower rate than a C corporation would pay on the
income.
@HELP
@H\01
Type in the name of your business,
then press "Enter" key.
@H\02
Enter "Y" ("Yes") if you are already in
business. If you are still planning to
start or acquire the business, enter "N"
("No").
@H\03
Note that if you were to sell your stock
in an S corporation, your tax basis for
the stock is likely to be something more
or less than your original cost, since
income or contributions to capital of
the corporation will have increased your
tax basis, and tax losses and distribu-
tions will have decreased your basis. So
you need to use your ADJUSTED tax basis
for your stock, not its original basis,
in "guesstimating" your gain or loss on
stock of an S corporation.
@H\04
Answer this question "Y" for "Yes" or
"N" for "No."
@H\05
An "S corporation" is a corporation that
has made an election (on Form 2553) for
Federal income tax purposes to have most
or all of its income & all of its losses
taxed directly to its shareholders, in-
stead of paying tax at the corporate
level. A corporation that is NOT an S
corporation is called a "C corporation."
Corporations may also elect treatment as
S corporations for state income tax pur-
poses, in all but a few states.
@H\06
Answer "Y" ("YES") if you anticipate tax
losses by your corporation, EVEN IF you
anticipate that such losses might not be
currently utilizable for some reason, by
a C corporation, or if passed through to
you by an S corporation.
@H\07
In computing your firm's estimated pre-
tax profits for the purposes of this
question, make the hypothetical assump-
tion that each owner will take out no
more than $100,000 a year in salary.
Thus, for example, if you actually in-
tend to take out $150,000 salary next
year, add back $50,000 to pre-tax cor-
porate income to do this calculation.
@H\10
Answer "N" ("NO") if you anticipate sub-
stantial losses, or credits but for some
reason, such as passive activity loss or
at-risk loss restrictions, or insuffici-
ent "tax basis," you do not expect to be
able to immediately use those losses (or
credits) on your individual income tax
return.
@H\11
In computing pre-tax profit for purposes
of answering this question, do not sub-
tract draws or salary taken out of the
business by you (or by other owners).
@H\12
Medical, disability, and group-term life
insurance fringe benefits for the owners
of a C corporation are treated very fav-
orably for tax purposes. Not only is
the amount paid for such insurance most-
ly nontaxable to the employee-owner, but
the benefits (insurance payments, etc.)
are generally tax-free to the recipient,
as well, except for disability benefits
(which are generally taxable to the em-
ployee, if the premiums were paid by the
corporation).
@H\13
To be a QPSC, a corporation must be en-
gaged almost exclusively in rendering
services in one of the fields listed,
and must be "substantially" (95%) owned
by its employees, retired employees, or
the estate of either (or by an heir, up
to 2 years after death).
The definition of a Qualified Personal
Service Corporation is very complex and
difficult to explain to anyone but tax
lawyers. At this point, you may wish to
exit to the menu of consulting subjects
and go thru the Q & A routine on QPSCs.
@H\14
Note that a Keogh plan, a Section 401K
plan, or an ESOP is a qualified plan.
However, an "SEP" ("Simplified Employee
Pension plan"), in which the employer
contributes to IRA accounts set up on
behalf of employees, is NOT considered
a qualified plan for purposes of this
analysis.
@H\15
In general, a participant in a pension
or profit sharing plan may borrow up to
$50,000 from the plan, but not over the
larger of the following two amounts:
. One-half of his or her vested
benefits under the plan; or
. $10,000.
An owner-employee is prohibited from
borrowing at all from an S corporation
plan, or from a Keogh plan (of an unin-
corporated business).
@H\16
Some types of corporations, such as typ-
ical professional corporations in many
states, provide little, if any, limita-
tion on liability since the laws in many
states provide that such corporations do
NOT limit liability for claims such as
professional malpractice damages, which
are a major area of exposure for most
types of professional corporations.
@H\17
"Adjusted Ordinary Gross Income" is the
ordinary GROSS income (excluding capital
gains) of a corporation, before any de-
ductions, except for certain adjustments
applicable to rental income and mineral
and oil and gas royalty income (such as
depreciation or depletion, property tax,
interest and rents paid), and other mis-
cellaneous adjustments that apply only
to certain kinds of special taxpayers
and types of income.
@H\20
Note that if your C corporation borrows
money to finance or carry its purchases
of dividend-paying stocks, in order to
benefit from the dividends received de-
duction, its interest deduction will be
reduced. It cannot deduct interest in-
curred to buy tax-free investments.
@H\21
Note that losses passed through by an S
corporation to its shareholders are not
necessarily deductible by a shareholder
if the shareholder has used up all the
"tax basis" of his stock (plus loans he
has made to the corporation). Nor can
such losses be used if they are consid-
ered "passive activity" losses, and the
shareholder does not have income from
other passive activities that he can
offset the passive losses against.
@H\22
Note that your corporation may be very
profitable, with significant taxable
income and tax liability, and yet may
still have significant tax credits that
it is carrying forward, due to the com-
plex interplay between tax credits and
the alternative minimum tax ("AMT") un-
der the tax law. Liquidation of the
corporation would cause any such carry-
overs, as well as any NOL carryovers,
to be lost forever.
@END