million, excluding a principal residence or income exceeding $300,000) obviously works best for C corporations (unless the shareholder limit on S corporations is waived by a legislative change that was pending when this book was published; see the Supplement for any update).
For non-accredited investors (those who do not qualify as accredited investors because they don't have annual income of $200,000, or $300,000 with a spouse), equity crowdfunding investments are capped at up to 10 % of annual income for those with income over $100,000, or up to $2,000 or 5 % of annual income, whichever is greater, for investors with annual income under $100,000.
All businesses hope to make money. But many sustain losses, especially in the start-up years and during tough economic times. The way in which a business is organized affects how losses are treated.
Pass-through entities allow owners to deduct their share of the company's losses on their personal returns (subject to limits discussed in Chapter 4). If a business is set up as a C corporation, only the corporation can deduct losses. Thus, when losses are anticipated, for example, in the start-up phase, a pass-through entity generally is a preferable form of business organization. However, once the business becomes profitable, the tables turn. In that situation, C corporations can offer more tax opportunities, such as fringe benefits. Companies that suffer severe losses may be forced into bankruptcy. The bankruptcy rules for corporations (C or S) are very different from the rules for other entities (see Chapter 25).
The tax law gives employees of corporations the opportunity to enjoy special fringe benefits on a tax-free basis. They can receive employer-provided group term life insurance up to $50,000, health insurance coverage, dependent care assistance up to $5,000, education assistance up to $5,250, adoption assistance, and more. They can also be covered by medical reimbursement plans. This same opportunity is not extended to sole proprietors. Remember that sole proprietors are not employees, so they cannot get the benefits given only to employees. Similarly, partners, LLC members, and even S corporation shareholders who own more than 2 % of the stock in their corporations are not considered employees and thus not eligible for fringe benefits.
If the business can afford to provide these benefits, the form of business becomes important. All forms of business can offer tax-favored retirement plans. Corporations make it possible to give ownership opportunities to employees. Corporations – both C and S – can offer employee stock ownership plans (ESOPs) in which employees receive ownership interests through a plan that is much like a qualified retirement plan (see Chapter 16). Certain C corporations can offer employees an income tax exclusion opportunity for stock they buy or receive as compensation. For 2017, 50 %, 75 %, or 100 % of the gain on the sale of qualified small business stock (explained in Chapter 7) is excludable from gross income, depending on when the stock was acquired, as long as the stock has been held for more than five years. C corporations can also offer incentive stock option (ISO) plans and nonqualified stock option (NSO) plans (see Chapter 7). The tax law does not bar S corporations from offering stock option plans, but because of the 100-shareholder limit (discussed earlier in this chapter), it becomes difficult to do so.
With whom you go into business affects your choice of business organization. For example, if you have any foreign investors, you cannot use an S corporation, because foreign individuals are not permitted to own S corporation stock directly (resident aliens are permitted to own S corporation stock). An S corporation also cannot be used if investors are partnerships or corporations. In other words, in order to use an S corporation, all shareholders must be individuals who are not nonresident aliens (there are exceptions for estates, certain trusts, and certain exempt organizations).
The number of owners also presents limits on your choice of business organization. If you are the only owner, then your choices are limited to a sole proprietorship or a corporation (either C or S). All states allow single-member LLCs. If you have more than one owner, you can set up the business in just about any way you choose. S corporations cannot have more than 100 shareholders, but this number provides great leeway for small businesses.
If you have a business already formed as a C corporation and want to start another corporation, you must take into consideration the impact of special tax rules for multiple corporations. These rules apply regardless of the size of the business, the number of employees you have, and the profit the businesses make. Multiple corporations are corporations under common control, meaning they are essentially owned by the same parties. The tax law limits the number of tax breaks in the case of multiple corporations. Instead of each corporation enjoying a full tax benefit, the benefit must be shared among all of the corporations in the group. For example, the tax brackets for corporations are graduated. In the case of certain multiple corporations, however, the benefit of the graduated rates must be shared. In effect, each corporation pays a slightly higher tax because it is part of a group of multiple corporations. If you want to avoid restrictions on multiple corporations, you may want to look to LLCs or some other form of business organization.
Both individuals and C corporations (other than PSCs) can enjoy graduated income tax rates. The top tax rate paid by sole proprietors and owners of other pass-through businesses is 39.6 %. The top corporate tax rate imposed on C corporations is 35 %. (There is some political support for reducing the top corporate tax rate.) Personal service corporations are subject to a flat tax rate of 35 %. (The domestic production activities deduction in Chapter 21 effectively lowers the top rate to less than 32 % for corporations that are eligible to claim it.) But remember, even though the C corporation has a lower top tax rate, there is a 2-tier tax structure with which to contend if earnings are paid out to you as dividends – tax at the corporate level and again at the shareholder level.
While the so-called double taxation for C corporations has been eased by lowering the tax rate on dividends, there is still some double tax because dividends remain nondeductible at the corporate level. The rate on qualified dividends for most taxpayers is 15 % (zero for taxpayers who are in the 10 % or 15 % tax bracket; 20 % for those in the 39.6 % tax bracket).
The tax rates on capital gains also differ between C corporations and other taxpayers. This is because capital gains of C corporations are not subject to special tax rates (they are taxed the same as ordinary business income), while owners of other types of businesses may pay tax on the business's capital gains at no more than 15 % (zero if they are in the 10 % or 15 % tax bracket; 20 % if they are in the 39.6 % tax bracket). Of course, tax rates alone should not be the determining factor in selecting your form of business organization.
Owners of businesses organized any way other than as a corporation (C or S) are not employees of their businesses. As such, they are personally responsible for paying Social Security and Medicare taxes (called self-employment taxes for owners of unincorporated businesses). This tax is made up of the employer and employee shares of Social Security and Medicare taxes. The deduction for one-half of self-employment taxes is explained in Chapter 13.
However, owners of corporations have these taxes applied only against their salary and taxable benefits. Owners of unincorporated businesses pay self-employment tax on net earnings from self-employment. This essentially means profits, whether they are distributed to the owners or reinvested in the business. The result: Owners of unincorporated businesses can wind up paying higher Social Security and Medicare taxes than comparable owners who work for their corporations. On the other hand, in unprofitable businesses, owners of unincorporated businesses may not be able to earn any Social Security credits, while corporate owners can have salary paid to them on which Social Security credits can be generated.
There have been proposals to treat certain S corporation owner-employees like partners for purposes of self-employment tax. To date, these proposals have failed, but could be revived in the future.
The additional Medicare surtaxes on earned income and net investment income (NII) are yet another factor to consider. The 0.9 %
