Tiếng anh chuyên ngành kế toán part 27 pps

248 Planning and Forecasting ex pected that the managers of an LLC will be held to the same fiduciary stan- dards as corporate directors and general partners of limited partnerships, re- sulting in their potential personal liability to the members. TAXATION Entrepreneurs make a remarkable number of significant business decisions without first taking into account the tax consequences. Tax consequences should almost never be allowed to force an entrepreneur to take actions he or she otherwise would not have considered. But often tax considerations lead one to do what one wants in a different manner and to reap substantial savings as a consequence. Such is often the case in the organization of a business. The fol- lowing discussion will be confined to the federal income tax, the tax with the largest and most direct effect upon organizational issues. Each entrepreneur would be well advised to consult a tax adviser regarding this tax as well as state income, estate, payroll, and other taxes to find out how they might impact a specific business. Sole Proprietorships Not surprisingly given the factors already discussed, a sole proprietorship is not a separate taxable entity for federal income tax purposes. The taxable in- come and deductible expenses of the business are set forth on Schedule C of the entrepreneur’s Form 1040 and the net profit (loss) is carried back to page 1, where it is added to (or subtracted from) all the taxpayer’s other in- come. The net effect of this is that the sole proprietor will pay tax on the in- come from this business at his highest marginal rate, possibly as high as 39.1% (in 2001), depending upon the amount of income received from this and other sources (see Exhibit 8.2). In Phil’s case, for example, if his software business netted $100,000 in 2001, that amount would be added to the substantial interest and dividend in- come from his other investments, so that he would likely owe the IRS $39,100 on this income. If Phil’s business were run as a separate taxable corporation, the income generated from it would be taxed at the lowest levels of the tax-rate structure, because this corporate income would not be added to any other in- come. The first $50,000 of income would be taxed at only 15% and the next $25,000 at only 25% (see Exhibit 8.3). This argument is turned on its head, however, if a business anticipates losses in the short term. Using Phil again as an example, if his business oper- ated at a $100,000 loss and as a separate taxable entity, the business would pay no tax in its first year and would be able to net its early losses only against profits in future years and only if it ever realized such profits. At best, the value of this tax benefit is reduced by the time value of money: At worst, the loss may never yield a tax benefit if the business never does more than break Choosing a Business Form 249 even. If Phil operated the business as a sole proprietorship, by contrast, the loss calculated on his Schedule C would be netted against the dividend and interest income generated by his investments, thus effectively rendering $100,000 of that income tax free. One can strongly argue, therefore, that the form in which one should operate one’s business is dictated in part by the likelihood of its short-term success and the presence or absence of other in- come flowing to its owner. EXHIBIT 8.2 Individual federal income tax rates. Under $6,000 Over $27,050 Over $65,550 Over $136,750 Over $297,350 Marginal tax rate (percent) Individual income 2001 0 10 20 30 40 50 Over $6,000 EXHIBIT 8.3 Corporate federal income tax rates. Below $50 >$50 >$75 >$100 >$335 >$10,000 >$15,000 >$18,333 Marginal tax rate (percent) Corporate income (thousands) 0 10 20 30 40 50 250 Planning and Forecasting Partnerships Partnerships are also not separate taxable entities for the purposes of the fed- eral income tax, although, in most cases, they are required to file informational tax returns with the IRS. Any profits generated by a partnership appear on the federal income tax returns of the partners, generally in proportions indicated by the underlying partnership agreement. Thus, as with sole proprietorships, this profit is taxed at the individual partner’s highest marginal tax rate, and the lower rates for the initial income of a separate taxable entity are forgone. In ad- dition, each partner is taxed upon his or her proportion of the income of the partnership regardless of whether that income was actually distributed. As an example, if Bruce and Erika, our hotel magnates, were to take $50,000 of a year’s profits to add a deck to one of their properties, this expen- diture would not lower the business’s profits by that amount. As a capital ex- pense it may be deducted over time only in the form of depreciation. Thus, assuming they were equal partners, even if Michael had objected to this ex- penditure, each of the three, including Michael, would be forced to pay a tax on $16,667 (minus that year’s depreciation) despite having received no funds with which to make such a payment. The result would be the same in a sole proprietorship, but this obligation is considered less of a problem since it can be expected that the owner would manage cash flow in a way which would min- imize this negative effect upon her- or himself. As with a sole proprietorship, this negative result becomes a positive one if the partnership is losing money. The losses appear on the partners’ individ- ual tax returns in the proportions set forth in the partnership agreement and render an equal amount of otherwise taxable income tax free. In addition, not all losses suffered by businesses result from the dreaded negative cash flow. As illustrated earlier in the case of the deck, the next year the hotel business might well break even or show a small profit on a cash-flow basis, but the de- preciation generated by the earlier addition of the deck might well result in a loss for tax purposes. Thus, with enough depreciation a partner might have the double benefit of a tax sheltering loss on his tax return and ownership of a growing, profitable business. This is especially true regarding real estate, such as the hotel itself. While generating a substantial depreciation loss each year, the value of the building may well be increasing, yielding the partners a cur- rent tax-sheltering loss while generating a long-term capital gain for a few years hence. Corporations Corporations are treated as separate entities for federal income tax purposes, consistent with their treatment for most other purposes. They have their own set of progressive tax rates, moving from 15% for the first $50,000 of income, through 25% for the next $25,000, to 34% and 35% for amounts above that. There are also 5% and 3% additional taxes at higher levels of income to Choosing a Business Form 251 compensate for the lower rates in the lower brackets. Certain “professional service corporations” have only a flat 35% rate at all levels of income. Also, losses currently generated by a corporation may be carried back as many as 2 years to generate a tax refund or carried forward as many as 20 years to shel- ter future income. Although corporate rates may be attractive at lower levels of income, the common fear of using the corporate form is the potential for double taxation. Simply put, the corporation pays tax upon its profits and then distributes the remaining profit to its stockholders as nondeductible dividends. The stockhold- ers then pay tax on the receipt of the dividends, thus amounting to two taxes on the same money. In 2001, for a corporation in the 34% bracket with stockhold- ers in the 27.5% bracket, the net effect is a combined tax rate of 52.15%. Yet double taxation is rarely a concern for the small business. Such businesses generally manage compensation to their employees, who are usually their shareholders, in such a way that there is rarely much, if any, corporate profit remaining at the end of the year. Since compensation (as opposed to dividends) is deductible, the only level of taxation incurred by such businesses is at the stockholder level. Other opportunities for legitimate deductible payments to stockholders that have the effect of eliminating corporate profit include rental payments on assets leased by a stockholder to the corporation and interest on that portion of a stockholder’s investment made in the form of debt. Thus, the existence of the separate corporate entity with its own set of tax rates presents more of an opportunity for tax planning than a threat of dou- ble taxation. If the corporation intends to distribute all of its excess cash to its owners, it should manage compensation and other payments so as to show little profit and incur taxation only on the stockholder level. If the corporation in- tends to retain some of its earnings in the form of capital acquisitions (thus re- sulting in an unavoidable profit for tax purposes), it can take advantage of the lower corporate rates without subjecting its stockholders to taxation at their level. Contrast this to a partnership where the partners would be required to pay tax at their highest marginal rates on profits that they never received. There are limits to the usefulness of these strategies. To begin with, one cannot pay salaries and bonuses to nonemployee stockholders who are not per- forming services for the corporation. Dividends may be the only way to give such shareholders a return on their investment. In addition, the Internal Rev- enue Service will not allow deductions for what it considers to be unreasonable compensation (as measured by compensation paid to comparable employees in the same industry). Thus, a highly profitable corporation might find some of its excessive salaries to employee-stockholders recharacterized as nondeductible dividends. Lastly, even profits retained at the corporate level will eventually be indirectly taxed at the stockholder level as increased capital gain when the stockholders sell their shares. For most startup businesses, however, this corporate tax planning strategy will be useful, at least in the short term. In addition, entrepreneurs will find certain employee benefits are better offered in the corporate form because 252 Planning and Forecasting they are deductible to employers but excluded from income only for employees. Since a sole proprietor or partner is not considered an employee, the value of benefits such as group medical insurance, group life insurance, and disability insurance policies would be taxable income to them but tax free to the officers of a corporation. Professional Corporations There are two common variations of the corporate form. The first of these is the professional corporation. Taxation played a major part in its invention. Originally, limitations on the amounts of money that could be deducted as a contribution to a qualified retirement plan varied greatly depending upon whether the business maintaining the plan was a corporation, a partnership, or a sole proprietorship. The rules greatly favored the corporation. Partnerships and sole proprietorships were required to adopt Keogh plans with their sub- stantially lower limits on deductibility. However, doctors, lawyers, architects, and other professionals, who often could afford large contributions to retire- ment plans, were not allowed to incorporate under applicable state laws. The states were offended by the notion that such professionals could be granted limited liability for the harms caused by their businesses. Eventually, a compromise was struck and the “professional corporation” was formed. Using that form, professionals could incorporate their businesses, thus qualifying for the higher retirement plan deductions but giving up any claim to limited liability. As time went by, however, the Internal Revenue Code was amended to eliminate most of the differences between the deduc- tions available to Keogh plans and those available to corporate pension and profit-sharing plans. Today, professional corporations are subject to virtually all the same rules as other corporations, with the exception that most are clas- sified as professional service corporations and therefore taxed at a flat 35% rate on undistributed profit. As the tax incentive for forming professional corporations has decreased, many states, perhaps with an eye toward maintaining the flow of fees from these corporations, have greatly liberalized the availability of limited liability for these corporations. Today in many states professional corporations now afford their stockholders protection from normal trade credit as well as tort li- ability arising from the actions of their employees or other stockholders. Of course, even under the normal business corporation form, a stockholder is per- sonally liable for torts arising from his or her own actions. Subchapter S Corporations The second common variation is the subchapter S corporation, named for the sections of the Internal Revenue Code that govern it. Although indistinguishable from the normal (or subchapter C) corporation in all other ways, including lim- ited liability for its stockholders, the subchapter S corporation has affirma tively Choosing a Business Form 253 elected to be taxed similarly to a partnership. Thus, like the partnership, it is not a separate taxable entity and files only an informational return. Profits ap- pear on the tax returns of its stockholders in proportion to shares of stock owned, regardless of whether those profits were distributed to the stockhold- ers or retained for operations. Losses appear on the returns of the stockholders and may potentially be used to shelter other income. Although the subchapter S corporation is often referred to as a small business corporation, the size of the business has no bearing on whether this election is available. Any corporation that meets the following tests may, but need not, elect to be taxed as a subchapter S corporation: 1. It must have 75 or fewer stockholders. 2. It may have only one class of stock (although variations in voting rights are acceptable). 3. All stockholders must be individuals (or certain kinds of trusts). 4. No stockholder may be a nonresident alien. 5. With certain exceptions, it may not own or be owned by another corporation. The subchapter S corporation is particularly suited to resolving problems presented by certain discrete situations. For example, if a corporation is con- cerned that its profits are likely to be too high to eliminate double taxation through compensation to its stockholders, the subchapter S election eliminates the worry over unreasonable compensation. Since there is no tax at the corpo- rate level, it is not necessary to establish the right to a compensation deduc- tion. Similarly, if a corporation has nonemployee stockholders who insist upon current distributions of profit, the subchapter S election would allow declara- tion of dividends without the worry of double taxation. This would undoubt- edly be attractive to most publicly traded corporations were it not for the 75-stockholder limitation. Many entrepreneurs have turned to the subchapter S election to eliminate the two layers of tax otherwise payable upon sale or dissolution of a corporation. The corporate tax otherwise payable upon the gain realized on the sale of cor- porate assets is eliminated by the use of the subchapter S election as long as the election has been in effect for 10 years or, if less, since the corporation’s incep- tion. Finally, many entrepreneurs elect subchapter S status for their corporations if they expect to show losses in the short term. These losses can then be passed through to their individual tax returns to act as a shelter for other income. When the corporation begins to show a profit, the election can be reversed. Limited Partnerships The tax treatment of limited partnerships is much the same as general partner- ships. The profits and losses of the business are passed through to the partners in the proportions set forth in the partnership agreement. It must be empha sized 254 Planning and Forecasting that these profits and losses are passed through to all partners, including lim- ited partners, even though one could argue that those profits and losses are de- rived entirely from the efforts of the general partners. It is this aspect of the limited partnership which made it the form of choice for tax-sheltered invest- ments. The loss incurred by the business (much of which was created on paper through depreciation and the like) could be passed through to the limited part- ners, who typically had a considerable amount of other investment and com- pensation income to be sheltered. Although the tax treatments of limited partnerships and subchapter S corporations are similar, there are some differences that drove the operators of tax shelters to use partnerships over the corporate form even at the risk of some unlimited liability. For one, although profits and losses must be allocated according to stock ownership in the subchapter S corporation, they are allo- cated by agreement in the limited partnership. Thus, in order to give the in- vestors the high proportion of losses they demand, promoters did not necessarily have to give them an identically high proportion of the equity. The IRS will attack economically unrealistic allocations, but reasonable allocations will be respected. In addition, whereas the amount of loss the investor can use to shelter other income is limited to the tax basis in both types of entities, the tax basis in subchapter S stock is essentially limited to direct investment in the corporation, while in a limited partnership it is augmented by certain types of debt incurred by the entity itself. Both types of entities are afflicted by the operation of the passive loss rules, added by the Tax Reform Act of 1986 in an attempt to eliminate the tax shelter. Thus, unless one materially participates in the operations of the entity (virtually impossible, by definition, for a limited partner), losses generated by those operations can normally be applied only against so-called passive income and not against active (salaries and bonuses) or portfolio (interest and divi- dend) income. Furthermore, owners of most tax pass-through real estate ven- tures are treated as subject to the passive loss rules, regardless of material participation. Limited Liability Companies LLCs are taxed in a manner substantially identical to limited partnerships. This combination of limited liability for all members (without the need to construct the unwieldy, double-entity, limited partnership with a corporate general part- ner) and a pass-through of all tax effects to the members’ personal returns, makes the LLC the ideal vehicle for whatever tax shelter activity remains after the imposition of the passive-activity rules. Technically, under recently adopted “check the box” regulations, LLCs, limited partnerships, and all other unincorporated business entities may choose to be taxed either as partnerships or as taxable corporations. Recogniz- ing that the vast majority of these entities are formed to take advantage of the opportunity to have taxable income or loss pass through to the owners, these Choosing a Business Form 255 regulations provide that these entities will be taxed as partnerships unless the entity affirmatively chooses to be taxed as a corporation. Most corporations have already achieved that level of comfort through the availability of the sub- chapter S election. Although the LLC would seem to have the advantage of affording tax pass-through treatment without the limitations of the subchapter S corporation rules, there are some disadvantages as well. Since the nonelecting LLC is not a corporation, it is not eligible for certain provisions the Internal Revenue Code grants only to the corporate entity. Among these privileges are the right to grant incentive stock options (ISOs) to employees and the right to take advan- tage of tax-free reorganizations when selling the company. LLCs must be con- verted to taxable entities well before relying on these provisions. CHOICE OF ENTITY The sole proprietorship, partnership, corporation (including the professional corporation and subchapter S corporation), the limited partnership, and the LLC are the most commonly used business forms. Other forms exist, such as the so-called Massachusetts business trust, in which the business is operated by trustees for the benefit of beneficiaries who hold transferable shares. But these are generally used for limited, specialized purposes. Armed with this knowl- edge and the comparative factors discussed previously, how should our budding entrepreneurs operate their businesses? Consulting Firm It will be obvious to Jennifer, Jean, and George that they can immediately eliminate the sole proprietorship and limited partnership as choices for their consulting business. The sole proprietorship, by definition, allows for only one owner, and there does not seem to be any need for the passive silent investors who would serve as limited partners. Certainly, none of the three would be willing to sacrifice the control and participation necessary to achieve limited partnership status. The corporation gives the consultants the benefit of limited liability, not for their own mistakes but for the mistakes of each other and their employees. It also protects them from personal liability for trade debt. This protection, however, comes at the cost of additional complexity and expense, such as ad- ditional tax returns, annual reports to the state, and annual fees. Ease of trans- ferability and enhanced continuity do not appear to be deciding factors, because a small consulting firm is often intensely personal and not likely to be transferable apart from its principals. Also, fear of double taxation does not appear to be a legitimate concern, since it is likely that the stockholders will be able to distribute any corporate profit to themselves in the form of compensation. In fact, to the extent that they may need to make some capital 256 Planning and Forecasting expendi tures for word-processing equipment and office furniture, the corpo- rate form would afford them access to the lower corporate tax brackets for small amounts of income (unless they were characterized as a personal service corporation). Furthermore, if the consultants earn enough money to purchase various employee benefits, such as group medical insurance and group life and disability, they will qualify as employees of the corporation and can exclude the value of such benefits from their taxable income, while the corporation deducts these amounts. These positive aspects of choosing the corporate form argue strongly against making the subchapter S election. That election would eliminate the benefit of the low-end corporate tax bracket and put our consultants in the po- sition of paying individual income tax on the capital purchases made. The elec- tion would also eliminate the opportunity to exclude the value of employee benefits from their personal income tax. The same problems argue against the choice of an LLC for this business. The other possibility would be the general partnership. In essence, by choosing the partnership the consultants would be trading away limited liabil- ity for less complexity. The partnership would not be a separate taxable entity and would not be required to file annual reports and pay annual fees. From a tax point of view, the partnership presents the same disadvantages as the sub- chapter S corporation and LLC. In summary, it appears that our consultants will be choosing between the subchapter C corporation and the partnership. The corporation adds complex- ity but grants limited liability. And it certainly is not necessary for a business to be large in order to be incorporated. One might question, however, how much liability exposure a consulting firm is likely to face. In addition, although the corporation affords them the tax benefits associated with employee benefits and capital expenditures, it is not likely that our consultants will be able to af- ford much in the way of employee benefits and capital expenditures in the short term. Further, these consultants will not likely have personal incomes placing them in tax brackets considerably higher than the corporation’s. A strong case can be made for either the C corporation or the partnership in this situation. One can always incorporate the partnership in the future if the busi- ness grows to the point that some of the tax benefits become important. It may also be interesting to speculate on the choice that would be made if our three consultants were lawyers or doctors. Then the choice would be between the partnership and the professional corporation. The comparisons would be the same except that, as a personal service corporation, the professional corporation does not have the benefit of the low-end corporate tax brackets. Sof tware Entrepreneur Phil can easily eliminate the partnership and the limited partnership. Phil is clearly the sole owner of his enterprise and will not brook any other controlling persons. In addition, his plan to finance the enterprise with earnings from his Choosing a Business Form 257 last business eliminates the need for limited partner investors. Almost as easily, Phil can eliminate the sole proprietorship since it would seem highly undesir- able to assume personal liability for whatever damage may be done by a prod- uct manufactured and distributed to thousands of potential plaintiffs. The corporation, therefore, appears to be Phil’s obvious choice. It gives the benefit of limited liability, as well as the transferability and continuity essential to a business that seems likely to be an acquisition candidate in the future. Again, the lack of size is not a factor in this choice. Phil will likely act as sole director, president, treasurer, and secretary. There remains, however, the choice between subchapters C and S. As may well be obvious by now, Phil’s corporation fits the most common profile of the subchapter S candidate. For the first year or more, the corporation will suf- fer serious losses as Phil pays programmers and marketers to develop and pre- sell his product. Subchapter S allows Phil to show these losses on his personal tax return, where they will shelter his considerable investment income. The passive loss limitations will not affect Phil’s use of these losses, since he is clearly a material participant in his venture. Phil could achieve much the same results by choosing an LLC, rather than a subchapter S corporation. Unfortunately, however, many states require that an LLC have two or more members, making Phil’s business ineligible. In states which allow single-member LLCs, there would be little to recommend one choice over the other. Phil might feel more comfortable with an S corpo- ration, however, if he fears that suppliers, customers, and potential employees might be put off by the relative novelty of the LLC. This might especially be true if he has any plans to eventually go public, as the LLC has not gained wide acceptance in the public markets. An S corporation can then usually revoke its S election without undue negative tax effect. Beginning as an S corporation would also eliminate the need to reincorporate as a corporation prior to selling the business in a potentially tax-free transaction. Hotel Venture The hotel venture contemplated by Bruce, Erika, and Michael presents the op- portunity for some creative planning. One problem they may encounter in mak- ing their decision is the inherent conflict presented by Michael’s insistence upon recognition and reasonable return for his contribution of the land. Also, Bruce and Erika fear being unduly diluted by Michael’s share, in the face of their more than equal contribution to the ongoing work. One might break this logjam by looking to one of the ways of separating cash flow from equity. Michael need not contribute the real estate to the busi- ness entity at all. Instead, the business could lease the land from Michael on a long-term (99-year) basis. This would give Michael his return in the form of rent without distorting the equity split among the three entrepreneurs. From a tax point of view, this plan also changes a nondepreciable asset (land) into de- ductible rent payments for the business. As their next move, the three may . reversed. Limited Partnerships The tax treatment of limited partnerships is much the same as general partner- ships. The profits and losses of the business are passed through to the partners in the. result becomes a positive one if the partnership is losing money. The losses appear on the partners’ individ- ual tax returns in the proportions set forth in the partnership agreement and render. the IRS. Any profits generated by a partnership appear on the federal income tax returns of the partners, generally in proportions indicated by the underlying partnership agreement. Thus, as with