3.3 Corporations

WEALTH AS A VACATION

Unless your partnership is formed as an LLC or a corporation, the advantages and disadvantages are similar to those of a sole proprietorship.

3.3 Corporations

There are generally two types of corporations: C corporations and S corporations. Larger businesses with multiple employees are often structured as C corporations; most smaller businesses choose to organize as S corporations. The main diff erence between the two is how taxes are paid. C corporations are taxed as independent entities, whereas the income of an S corporation “passes through” to the individual tax returns of its owners.

A corporation is a separate legal entity. It is formed under state law. The corporation owns the business and all of its assets and properties. The shareholders own the corporation. The main advantage of incorporating is that shareholders are not liable for the business’s debts. Instead, the corporation is liable. This structure might be the right business type for your VRP if you want:

• Venture capital for fi nancing • Flexible profi t-sharing among owners • Company earnings to stay in your business so it can grow • Flexibility to spread the VRP rental revenue between the corporation and shareholders for tax-planning purposes • Flexibility to set salaries for employees/owners to minimize taxes. • Flexibility to provide (through the corporation) substantial health and medical benefi ts and other benefi ts • To be able to sell your VRP business with ease at some point in the future • To provide an accountable plan for travel and entertainment of clients • To be able to off er employees stock options

CHAPTER 3

Tax Differences Once you’ve incorporated your business, you have to decide whether it should be taxed for income tax purposes as a C corporation or an S corporation.15 A C corporation (C corp) gets its name because it is taxed under Subchapter C of the Internal Revenue Code. The corporation is a separate taxpayer, with income and expenses taxed to the corporation. If corporate profi ts are then distributed to the shareholders as dividends, the shareholders must pay personal income tax on the distribution. This results in double taxation of profi ts. As a result, many small businesses do not opt for C corporation tax status.

You can decide to have S corporation status instead by fi ling a form with the IRS (and with your state, if applicable) so profi ts, losses, and other tax items pass through the corporation to you and any other shareholders and are reported on the shareholders’ personal tax returns. The S corporation is taxed under Subchapter S of the Internal Revenue Code. It does not pay tax. Not every corporation qualifi es to be an S corporation. There are restrictions imposed by the tax law on the number and type of shareholders for an S corp, for example.

While a C corporation or C corp is the most common corporation type, it isn’t always the top choice for small business owners. C corporations provide limited liability protection to owners, called shareholders. This means owners are typically not personally responsible for business debts and liabilities.

C Corp Advantages C corporations are more fl exible than S corporations. For example, there are more options as far as the number of owners (shareholders) they can have and who can be an owner. That is one reason why C corps are often the preferred business type for venture capitalists when they provide funding to a business. Keep in mind, however, that

15. https://www.bizfi lings.com/starting-your-business/incorporation-options Accessed May 16, 2019.

WEALTH AS A VACATION

corporations face the most extensive and ongoing formalities of any business type. Corporate formalities are steps and precautions that the business must take to ensure it remains legally distinct from its owners.16 This means that C corporations must adopt and regularly update bylaws, hold and properly document annual meetings of directors and shareholders, and more.

Starting a C corporation provides the following advantages:

• Limited liability protection • Unlimited owners • Easy transfer of ownership through the sale of stock • Unlimited life: When a C corporation’s owner dies, the corporation does not cease to exist. • Salaries paid to owners of C corporations are deducted from C

Corp profi ts for income tax purposes. • Tax advantages: Unlike pass-through entities like LLCs, earnings of a C corporation are only taxed to owners if distributed as dividends. • The ability to raise capital. Money can be raised by selling shares of stock. • Retained earnings inside the business. A C Corp can retain earnings for reasonable business needs, if it complies with the accumulated earnings tax provisions. • Credibility: C Corps may be perceived as a more professional/ legitimate entity than a sole proprietorship or general partnership in the eyes of your VRP guests. • Lower audit risk: C corporations are audited less frequently than other business structures. • Tax deductible expenses: Business expenses may be taxdeductible. This is big for a VRP owner, as running a VRP typically comes with many expenses.

16. https://www.legalmatch.com/law-library/article/corporate-formalities-checklist.html Accessed May 16, 2019.