Essentials of taxation 2016 cengage chapter 18

Chapter 18 Comparative Forms of Doing Business Essentials of Taxation © 2016 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part The Big Picture (slide of 2) • Bill and George are going to start a new business in which they both will participate on an active basis – They will use savings to finance the business • They have narrowed the choice of business forms to – A C corporation, – An S corporation, or – An LLC • Limited liability is important in their choice of business form, but minimizing taxes is also important • They expect losses for the first years of operations, but after that they expect to earn $200,000 in before-tax profit – Any after-tax profit will be distributed to Bill and George The Big Picture (slide of 2) • George also is considering investing $10,000 in a limited partnership – He provides you with information on projected partnership profits and losses See Example • As a way of leveraging the risks and rewards associated with his investments, Bill earlier had acquired a 30% interest in a boutique retail coffee franchise outlet – Bill now is considering selling this investment, which has experienced rapid appreciation – He needs to know the adjusted basis of his ownership interest See Example 13 • Read the chapter and formulate your response Choice of Form of Business Entity • Many factors affect the choice of business entity – Both tax and nontax – Understanding the comparative tax consequences related to the different types of entities is important for effective tax planning Principal Forms of Doing Business • Sole Proprietorship • Partnership • C corporation • S corporation • Limited liability company (LLC) Limited Liability Company (LLC) • Hybrid business form that combines the corporate characteristic of limited liability for owners with tax characteristics of a partnership The Big Picture – Example Nontax Factors (slide of 2) • Return to the facts of The Big Picture on p 18-1 • George is considering investing $10,000 in a limited partnership • He projects that he will be able to deduct the $10,000 capital contribution within the next years (as his share of losses) – Since George’s marginal tax rate is 28%, the deductions will produce a positive cash-flow effect of $2,800 ($10,000 X 28%) The Big Picture – Example Nontax Factors (slide of 2) • However, there is a substantial risk that he will not recover any of his original investment – If this occurs, his negative cash flow from the investment in the limited partnership is $7,200 ($10,000 - $2,800) • George must decide if the investment makes economic sense Filing Requirements Sole Proprietorship • Files Schedule C, Form 1040 C Corporation •Files Form 1120 Partnership & LLC • Files Form 1065 S Corporation • Files Form 1120S Nontax Factors—Capital Formation Sole Proprietorship Partnership • Limited ability to raise capital • Can raise funds through pooling of owner resources • Ltd p’ship can raise capital from investors C Corporation S Corporation • Greatest ease and potential for raising capital • Greatest ease and potential for raising capital, but limited number of investors Tax Attributes of Different Business Forms (slide of 19) S Corp Contribution of Property to Entity Character of Income Taxed to Owners Taxable unless meets §351 Conduit-retains source characteristics C Corp Taxable unless charactermeets §351 All source istics lost when income distributed to owners Tax Attributes of Different Business Forms (slide of 19) Loss Allocation to Owners Limitation on Loss Deductible by Owners Sole Prop Not applicable liabilities of business Amount invested plus Partnership Profit and loss Ptr’s investment plus sharing ratios share of partnership liabilities Tax Attributes of Different Business Forms (slide of 19) Loss Allocation to Owners Limitation on Loss Deductible by Owners S Corp Per share/ per day S/holder’s investment plus loans from s/holder to corporation C Corp Not applicable Not applicable Tax Attributes of Different Business Forms (slide of 19) Sole Prop., Partnership and S Corp At-risk Rules Applicable? Passive Loss Rules Applicable? Yes, at the owner, partner or shareholder level Indefinite carryover of unused losses Yes, at the owner, partner or shareholder level Indefinite carryover of unused losses Tax Attributes of Different Business Forms (slide 10 of 19) At- risk Rules Applicable? C Corp Yes, for closely held corporations Indefinite carryover of unused losses Passive Loss Rules Applicable? Yes, for closely held and personal service corporations Indefinite carryover of unused losses Tax Attributes of Different Business Forms (slide 11 of 19) Capital Gains Sole Prop Owner level 0/15%/20% tax Capital Losses Up to $3,000 against ord income Indefinite carryover of excess Partnership Conduit-owners Conduit-owners and S Corp report shares same report shares same as Sole Prop as Sole Prop C Corp Taxed at Corporate Carried back yrs, level up to 35 % forward Can only offset capital gains Tax Attributes of Different Business Forms (slide 12 of 19) Consequence of Treatment of Earnings Retained Nonliquidating by Owners Distributions Sole Prop Taxed when earned; increases investment in S.P Not taxable Partnership Same as S.P Not taxable unless cash or liability relief > Ptrs basis Tax Attributes of Different Business Forms (slide 13 of 19) Consequence Treatment of Of Earnings Retained Nonliquidating by Owners Distributions S Corp Same as S.P Generally not taxable unless distribution > AAA or stock basis May be dividend if E & P from Sub C year C Corp Taxed to corp as Taxed in yr received up to earned Possible AE & P or if > stock basis AE Tax Tax Attributes of Different Business Forms (slide 14 of 19) Sole Prop Sale of Ownership Interest Treated as a sale of each asset Gain character depends on asset nature Partnership Treated as sale of underlying ordinary income assets Remainder treated as sale of partnership interest (capital gain) Tax Attributes of Different Business Forms (slide 15 of 19) Sale of Ownership Interest S Corporation Treated as sale of corporate stock or C Corp (capital gain) Loss may be ordinary if §1244 applies, otherwise capital Tax Attributes of Different Business Forms (slide 16 of 19) Fringe Benefits §1244 Built-in Avail to Owners? Available? Gains effect? Sole Prop No P’ship No No N/A No N/A S Corp Some if < 2% Yes Possible corp owner level tax C Corp Available Yes Limited by anti-discrim.rules No effect Tax Attributes of Different Business Forms (slide 17 of 19) Sole Prop §1231 Gains and Losses Foreign Tax Credits Taxable or deductible Owner level by owner yr lookback rule Partnerships Conduit—same and S Corps as S.Prop Conduit—same as S.Prop C Corp Available Taxable/deductible at corp level yr Corporate level lookback rule Tax Attributes of Different Business Forms (slide 18 of 19) Tax Alternative Min Tax ACE Adjustment Preference Items Sole Prop Applies at owner level (26% or 28%) N/A owner level Determined at Partnership Applies at or S Corp ptr or (26% or 28%) owners for their N/A preferences level AMT calc Conduit—entity shareholder pass thru to Tax Attributes of Different Business Forms (slide 19 of 19) Alternative Min Tax C Corp ACE Adjustment Applies at Corp 75% x (ACE level (20%) -AMTI) is added to AMTI (or subtracted) Tax Preference Items Subject to AMT at corporate level If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr Donald R Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta © 2016 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 71 ... Utilization of special allocations – Minimizing double taxation Minimizing Double Taxation of C Corporations (slide of 5) • Several techniques are available for reducing the double taxation of C corps... qualified dividends reduces the potential negative impact of double taxation Minimizing Double Taxation of C Corporations (slide of 5) • Make return of capital distributions – For ongoing businesses,... costs Single vs Double Taxation Sole Proprietorship Partnership and LLC • Single taxation • Single taxation C Corporation S Corporation • Double taxation • Generally, single taxation • May be subject