Every organization structure has its benefits and drawback when taxation is taken into consideration. Taxation is not treated similarly in sole proprietorship, partnership and in S corporations. In sole proprietorships and partnerships, tax is not only borne by the firm but also by the owners since there are not distinct from the business (Wahab & Holland, 2012).. However, in S corporation, there is limited liability which shows that the company and the owner are very distinct entities. Undoubtedly, S corporation has benefits in taxation as it enjoys advantages over sole proprietors, partnership organizations, and C corporations. For instance, in the other businesses, there is double taxation like in the case of a sole proprietorship the owner taxation encompasses all the incomes (Wahab & Holland, 2012).. Therefore, I would propose to Bob that he adopts an S corporation as it is the safest form of entity when it comes to operations, taxation and liability.
Benefit of an S corporation over other businesses
Cash basis vs. Accrual basis
Bob is recommended to use S corporation. There is no inventory requirements under this form of business thus, it makes it easier and suitable for him to use cash accounting system rather than the accrual accounting system which is mostly used by sole proprietorship and other forms of business where inventory is kept.
Under cash accounting system, income is taxable once only when it has been received unlike in accrual accounting system. However, certain recent changes have been made in tax regulation and law which has resulted in the formation of the Small Business Job Protection Act of 1996 that has made the S corporation eye-catching for the entrepreneurs and business owners (Schenk, 2014).
Cost to prepare returns
Although it is recommended for Bob to adopt S Corporation, it should be noted that the cost related to preparation and filling returns is relatively lower compared to the other forms of business such as C corporations. This is due to the statutory requirement that requires companies to prepare detailed financial statements at the end of each trading period whereas in C corporations, returns may be filed yearly, semi annually or quarterly, thus, making it somehow expensive for C corporations.
Tax benefits and limited liability protection
In S corporations, there are tax benefits as well as limited liability protection. However, there are some disadvantages associated with S corporations. For instance, they are numerous requirements that must be adhered to which results to higher tax and legal service costs.
They are required to submit the articles of association and memorandum of association. They ought not to commence business unless they obtain a certificate from the registrar of companies. It is also mandatory to hold regular shareholders meetings mostly annually (Graham, Raedy & Shackelford, 2012)
The company employees and shareholders enjoy full limited liability protection. Their personal assets cannot be used to pay for the losses of the corporations. This is what is referred to as limited liability.
The proprietors of C corporation experience double tax due to the payment of federal tax on income and taxes imposed on dividends. Conversely, in an S corporation taxation is only once that is on the revenues of the organization. Apparently, the S corporations have simplified tax as they do not have to remit tax in a company level. Undoubtedly, this provides for a reduced amount of money paid for the taxes on the business earnings. In a partnership and a sole ownership, the proprietors pay self-employment tax, which is not payable to an S corporation. For instance, a case can arise where a proprietor is also a worker in an S corporation. Without a doubt, in such a scenario the shareholder may remit the self-employment salary as earnings arising from the company. Basing on the fact that the proprietor is technically a worker in the corporation, self-employment taxes will not be obligatory. Apparently, the individual will only pay the income tax as the salary, and the dividend will not be subjected to taxation (International Business Publications, USA, 2008).
Taxation preparation varies with the consulting firms, the region, and the type of taxes to be computed the expenditures to be incurred in preparing of are a constituent of various variables. Nonetheless, according to US Tax Centre, (2015) preparation of taxes in an S corporation are not cumbersome as the most crucial item to factor is the income statements. The average cost of computing taxes for the partnership are higher than the S corporation as mean cost of filing form 1040 per individual is $218. The average cost of filing a form 1120s for the S corporation is $761 which is less than filling form 1120 for Sub C, which amounts to $806. Undeniably, the expenditures incurred in taxation preparation in S corporation are affordable.
Corporations and limited liability companies all enjoy protection on the individuals properties. However, the liability of partners in a partnership and proprietors in a sole ownership are not limited. The owners in this organization may lose their personal property in cases of liquidation or when creditors owe the organization amounts which is more than the organization assets. The limited companies and S corporations are in most cases suitable for an organization which is not large. Unequivocally, with an S corporation, it is easier to expand the business with time and acquiring new proprietors is easy. The earnings from S corporation must pass through the proprietors who in turn remit taxes on their individual earnings. As the owner of the Business Bob will also be a worker of the organization thereby the medical care taxes will be paid from compensation receipts rather than the amount arising from distribution. The taxes on social security will also have the same criteria for medical care (IRS, 2015).
Raising capital in an S corporation is easier than a sole proprietorship because the credibility of the organization by the stakeholders is high. In a sole proprietorship, the credit worthiness is determined by taking into account the owners assets. An S corporation is allowed to use cash accounting method by IRS in cases only when the company does not have inventory. The method used has a significant influence on the tax payable. The S corporation can use either of the methods, but the cash method is more suitable as cash is recognized when earned and not when it is received. The payment of $180 000 and $70,000 will reduce the taxable income as the tax base will reduce. The business for the first few years may opt to use the cash basis and switch to the accrual method later as indicated in the IRS schedule 446b (James , 2011).
Percentage of ownership
Mandy Jones can be considered as an employee who can also translate to a shareholder. As an owner, she will have shares which are less than that of Bob making her a minority shareholder. The salary received from the business will be deemed as income from the business and will be taxed on here thereby the business will not incur self-employment tax. The S corporation will be organized in a way that the incomes will be subdivided into two the portion for distribution and the portion of earnings. Indeed, to avoid audits by the IRS or suspicion, Mandy Jones will have to receive a significant amount of income which will be subject to self-employment tax on her. The amount set aside for distribution will not be subjected to this tax but will only be subjected to the ordinary corporate tax.
Mandy will incur a high percentage of self-employment taxes but will also have an augmented income from the business. As a shareholder, some duties will be delegated to her, and she will lower the burden of responsibility. The taxation will depend on the amount of shares in the business. For instance, if she has a shareholding of 40 % that is the percentage of income that will be taxed. In a case where she will earn $70,000 and Bob earns $ 180,000 the shareholding on the organization will be presumed to be 28%, and that of Bob will be 72%. The self-employment tax will be imposed on the individual tax, and the business will only be subjected to corporate income tax. Money paid regarding the dividend will not be subjected to tax as this occurs in the C corporation where double taxation is experienced. Planning of the S corporation will be essential in achieving the desirable benefits when compared to a sole proprietorship (International Business Publications, USA, 2008).
Strategic estate planning
The IRS code is responsible for the creation of the S corporation which is a corporation which represents a corporation where the owner has an important amount of investment. Revocation of an S corporation status can lead to a disaster not only to the owner but family of the proprietor in the case of demise. Undeniably, having a laid bad plan on the estates is vital to be it the S corporation will be passed on to as a gift or estate. In fact, taking into account various circumstances S corporation can be held in by estates or trusts. In a scenario where the shares are transferred to Mandy Jones after passing of the proprietor, and she is not a qualifying owner, this will affect the business negatively. The consequence will be termination of the S corporation, and the organization will be subjected to corporate level taxes.
The best way to protect the business is to ensure that the shares of Mandy are qualifying. Qualifying Trusts can be categorized into grantor's trust or the QSSTs, ESBTs the voting trusts. The IRS code provides particular requirements to various trust. Incontestably, it would be advisable to seek legal counsel from an attorney before try users of shareholding in an S corporation. A clause should be written in the agreement providing that all transfers should be terminated until legal counsel is provided on the implications of the move. Undoubtedly, this will ensure that the organization will continue enjoying the S corporation status in case of an unfortunate event such as passing away. A continuous review is required for the eligibility of Mandy on taking over the business, and this will ensure if she cannot inherit the business alternative measures need to be put in place (Kluwer, 2014).
Selling S Corporation
The vital consideration that should be made in the treatment of tax when selling an S corporation is how you approach the transaction on the sale. The seller of the S corporation can approach the sell in two ways, that is, selling the stock of the S corporation and the second approach is selling its assets. The second approach helps to maintain the existing structure of the corporate intact. However, the simplest way for the owner is to undertake the transaction by selling the stock of the S corporate. If the owner plans to undertake the transaction through the sale of stock, for the purpose of taxation, take the amount of cash received from the sale of stock by the owner, then subtract the owners tax basis in the S corporation shares. Although determining the tax in S Corporation is somehow complicated. However, the owners basis will be the business owner investment in capital. The capital investment will still be adjusted for any differences in the taxable income the business has adjusted in its tenure and any amount withdrawn from the business by the owner on the profits distributed. In instances where some proceeds are higher from t...
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