David Knoble, CPA, PLLC

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What is the Best Company Form?

What is the best com­pany form for your busi­ness?  Should you be a Cor­po­ra­tion or a Part­ner­ship?  A C-Corporation or an S-Corporation?  What about an LLC?  Pick­ing the right com­pany form is extremely impor­tant when you start a new busi­ness.  It is eas­ier to choose then and there are more tax con­se­quences as a result of chang­ing later.  How­ever, chang­ing is not impos­si­ble and there are cir­cum­stances where you may wish to move to a dif­fer­ent com­pany form.

C-Corporations are the form most pub­lic com­pa­nies are today because of the inher­ent struc­ture of many share­hold­ers.  In fact, many older pri­vate com­pa­nies are also C-Corporations.  The largest draw­back of a C-Corporation is the dou­ble tax­a­tion — one at the com­pany level and then again when the share­holder receives distributions.

Part­ner­ships and LLC’s, how­ever, only have one level of tax­a­tion.  Each dol­lar of income is taxed at the owner’s level only one time.  Part­ner­ships and LLC’s have restric­tions that may pre­clude using that form.  Even so, most small busi­ness can use a Part­ner­ship or LLC form for their busi­ness and will ben­e­fit from the sin­gle level of taxation.

One advan­tage of an S-Corporation over LLC’s and Part­ner­ships is the tax­a­tion of wages.  An S-Corporation can deduct rea­son­able wages for the own­ers — and these wages are not taxed as self-employment wages.  While there are vol­umes of infor­ma­tion from the IRS and court cases deter­min­ing what rea­son­able wages are, com­mon sense will typ­i­cally help keep you in good graces.

LLC’s and Part­ner­ships are dif­fer­ent.  All earn­ings to the mem­bers or part­ners are taxed as self-employment wages.  Any pay­ments made to offi­cers who are also own­ers are self-employment earn­ings.  Thus, pay­ing wages, rea­son­able or not, has no bear­ing on self-employment tax — all the earn­ings are taxed.

What if you are already a C-Corporation?  What are your choices for change?  As it turns out, the IRS does allow you to change your com­pany from a C-Corporation to a Part­ner­ship or LLC.  In most cases, the best form to change to is an S-Corporation.  This has to do with cur­rent ver­sus delayed taxes in the retained earn­ings of the C-Corporation.

The cur­rent down­turn in the econ­omy may present your com­pany with an oppor­tu­nity to switch to a Part­ner­ship or an LLC with very lit­tle tax effect.  Depend­ing on the value of your com­pany and the com­pany assets, mov­ing to an LLC may be advan­ta­geous.  Typ­i­cally, mov­ing to a Part­ner­ship or an LLC from a C-Corporation causes the own­ers to pay income tax imme­di­ately.  This tax is gen­er­ated on the dif­fer­ence between the value of the Cor­po­ra­tion and the basis that the share­hold­ers have in the stock.  How­ever, if the value is lower or equal to the shareholder’s cur­rent basis, then there is lit­tle to no tax owed.

If you have been think­ing about chang­ing your com­pany form, now is a good time to con­sider it.  This arti­cle is an over­sim­pli­fi­ca­tion of the process and the rules and reg­u­la­tions can be daunt­ing.  Call your CPA and meet with them to dis­cuss the specifics.  They can help you for­mu­late a plan and deter­mine what your tax effect will be.  Each com­pany is different.

© 2009, david.knoble
by David Kno­ble, CPA, PLLC
Serv­ing Non-Profits, Busi­nesses & Indi­vid­u­als
Rock Hill, SC

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