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Business Entity Selection And Formation

It is not uncommon for an individual to form a corporation or LLC without sufficient tax and legal advice and without any understanding of what they created or how it works.


If you are considering the formation of a business entity, the professionals at Assurity Financial Group highly recommend meeting to gain an understanding of your future business and weigh the pros and cons of entity structures listed below.


A corporation is often described as an “artificial person.” A corporation has independent legal status, can own property, can conduct business, pay taxes, and can sue or be sued. Ownership of a corporation is represented by shares of stock owned by shareholders, and ownership can be transferred by sale of stock. Corporations are formed under state laws and fall under special rules under the Internal Revenue Code for federal tax purposes.


Historically, one of the primary reasons for the existence of corporations is to encourage innovation and commerce by allowing individuals to pool their resources to operate a business while being protected from extended liability. If a corporation is set up and operated properly, the shareholder’s risk of loss is limited to the amount invested in stock and amounts loaned to the corporation.


In many small corporations, shareholders often do not understand and adhere to the necessary corporate formalities, and they put themselves at risk for “piercing the corporate veil” in the event of a lawsuit.


A ‘C’ corporation computes taxable income and pays tax in a similar manner to an individual. After-tax corporate earnings, known as earnings and profits, are distributed to shareholders in the form of dividends, which are taxable to the shareholders. A C corporation’s ability to retain corporate earnings is limited to the amount needed for bona fide business reasons.


An ‘S’ corporation may be subject to payroll taxes or other taxes in the form of fines or penalties, however, a S corporation is not subject to federal income tax. Instead, earnings from an S corporation flow through directly to shareholders on Schedule K-1, Form 1120S. State laws vary on taxation of S corporations. An S corporation can provide tax benefits for shareholders, including avoidance of double taxation that exists with a C corporation and reduced FICA tax on earnings as compared to a general partner. Adhering to corporate formalities, including strict rules on distributions to shareholders, is necessary to ensure the S corporation status is maintained.


Many S corporations are set up for the primary purpose of avoiding self-employment tax and payroll taxes on wages for shareholders. The structural process is straightforward. Instead of taking profits as wages, the person can form an S corporation and take income as S corporation earnings not subject to payroll tax. However, this approach does not comply with tax law, and the IRS continues to crack down on such “tax planning” techniques.


Limited Liability Companies (LLCs) The same principles apply to limited liability protection for LLCs, and it can also apply to maintaining the benefits of a partnership structure. These business entities must be operated as separate legal entities to ensure the tax benefits and limited liability aspects of forming a separate business entity.


“Piercing the Corporate Veil” In the event of litigation for damages, plaintiff attorneys are likely to attempt to pierce the corporate veil in situations involving small corporations. If the court agrees to pierce the corporate veil, the liability protection offered by the corporation vanishes, and the shareholder(s) is held personally liable for damages.


Almost anything a shareholder of a small corporation does has the potential to pierce the corporate veil and destroy the reasons for creating the corporation in the first place. Using the wrong stationery, taking a loan from the corporation, using personal funds to buy office supplies, or failing to pay reasonable compensation can cause a court to destroy the protection a shareholder seeks. The best prevention of problems is for the taxpayer to make an appointment to meet with Assurity Financial Group today to understand the formalities that must be followed prior to establishing the corporate entity.





Business Entity


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