Your chosen form Featured

8:00pm EDT July 21, 2002

Part 1 of a 2-part series

It’s not a revelation that a business’s chosen form must fit your needs, and that these needs and the business itself will change over time. Among other things, the business structure will impact the amount of tax you have to pay. You’ll find distinct advantages and disadvantages with each form of doing business — which is why it’s important to annually review your business’ structure.

In recent years, most businesses started in Pennsylvania, other than those in which a single individual is the entire company, have been Subchapter S corporations or Limited Liability Companies (more on this next month), mainly because of the tax advantages. Consider the following.

S corporations

S corporations, unlike C corporations, are not taxed twice. Owners don’t pay federal corporate tax or Pennsylvania corporate tax, which is 9.999 percent.

The disadvantages are that S corporations can only have a limited number of shareholders (75), and employee benefits. such as medical insurance and group term life insurance, are taxable as ordinary income to employee owners who own more than 2 percent of the subchapter S corporation. In past years, subchapter S corporations were only allowed to have certain types of shareholders, primarily individuals and certain specialized S corporation trusts.

In recent years, the tax law was changed to allow the following types of entities to be shareholders in S corporations: 1) electing small business trusts, 2) qualified retirement plan trusts, and 3) tax-exempt organizations.

If you plan to keep your company private (not a publicly traded entity) for an extended period of time, it usually makes sense to keep it as an S corporation. If the reverse is true, you may want to change to a C corporation.

C corporations

A primary advantage of a C corporation is the unlimited number and types of shareholders. The differential in the tax brackets between an individual and corporation sometimes makes a C corporation structure more attractive, especially if the C corporation is going to be sold in the near future.

If your personal tax bracket is 39.6 percent and the corporation’s is 15 percent, you can withdraw profits as nontaxable fringe benefits from the corporation or receive a higher value for the corporation when your stock is sold. The gain would be taxed at a maximum capital gains rate of 20 percent.

C corporations can have multiple classes of stock; S corporations can only have one, but these can be voting or nonvoting stock. This counts as one class.

When it comes to liability issues, C and S corporations offer advantages over other forms. Both offer protection from personal liability for business debts. Only the investment is at risk. However, frequently when the corporation, especially if it’s a small one, applies for a bank loan, lead shareholders and their spouses may be required to personally guarantee repayment.

When you review your company’s structure, do so in conjunction with your financial adviser, accountant, and attorney. State income and local taxes should also be considered.

Louis P. Stanasolovich is founder and president of Legend Financial Advisors, Inc., a fee-only North Hills Securities and Exchange Commission registered investment advisory firm that provides asset management and comprehensive financial planning services to individuals and businesses. Reach him at (412) 635-9210. The firm’s Web site is www.legend-financial.com.