Our client, Individual #1, is currently earning $350k in gross receipts and $175k in gross profit, respectively, from his IT consulting business. In discussions with the client, we learned he wants to transition his sole proprietorship/LLC into either an S-Corp or C-Corp. I propose his reorganization as an S-Corp as although it limits his potential for equity investment, it provides both a liability and tax shield.
1) Section 351: Since Individual will be in control (80%+ ownership) of future corporation, he will not incur a taxable event a. Liability exceptions – tax avoidance or transfer was not for a bona fide business purpose b. If liabilities are in excess of Individual’s tax basis
As the above code references, Individual will not incur an initial taxable event. Accordingly the below discusses and details the strategies available to him
| S Corp
| C Corp
| Owner / Flow-Through
| Entity – carry forward 20 yrs, carry back 2 yrs
| Self-employment Tax
| Limited to 100 shareholders
Distribution to shareholders
| Not subject to double taxation
| Subject to double taxation
1) Responsibility for liabilities are at the entity level * If lawsuit is filed or for the repayment of debts, Individual will benefit as only assets of the corporation can be disgorged 2) Both structures can source capital from equity investors. However, whereas C-Corp entities can access an unlimited number of investors, S-Corps are limited to 100 shareholders
The Benefits/Drawbacks of an S-Corp
1) Losses generated from flow-through entities can offset personal income * Additionally, Individual can deduct entity losses from personal income in the current period which provides a significant advantage as firms tend to report losses during the early stages of establishment * Limited to basis, at-risk...
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