If you are creating a new business or unhappy with your current business structure, you need to consider the appropriate business entity. Whether to incorporate or form a limited liability company (LLC) is not always obvious. Under the Internal Revenue Code (IRC), a corporation is either a “C Corp” or an “S Corp.” An LLC is either a sole proprietorship (single member), a partnership (two or more members), a “C Corp,” or an “S Corp (if it meets all of the requirements and files a timely election).”

Tax issues to consider when choosing an entity: Sale of the business/liquidation. Tax rate exposure. Utilization of losses by the shareholders/members. Compensation/fringe benefit packages. Payroll tax liabilities and associated complexities. And state taxes.

Non-tax issues to consider: Limited liability protection for shareholders/members. The capital structure of the entity. Buy-sell agreements. The type of business/investment activity. And the applicable state law and other corporate legal formalities.

As indicated, there are many reasons to choose one structure over another. With that in mind, here is a brief description of these business entities

Sole Proprietorship

The simplest and least expensive structure. Works best if you are on your own, in a low risk business. No double taxation on profits, such as under a “C Corp.” Profits/losses reflected on Form Schedule C of the Form 1040. Unlimited liability for the owner and all income subject to the onerous “self-employment” tax.

Partnership

An unincorporated business that has two or more partners. There are two types: general and limited. In a general, partners share in management and are each 100% responsible for the partnership obligations. In a limited, there are general and limited partners. The general partners manage the business and are personally liable for obligations. The limited partners cannot participate in management, but share in the profits. Their liability is limited to the amount of their capital contributions. Profits are taxed only once, at the partners’ marginal tax rate.

C Corporation

They are taxed (federal and state) at the entity level and are subject to taxes on income generated by the business. Shareholders pay taxes (double taxation) on the profits distributed (dividends) to them. Liability is limited to the shareholder’s investment. They have an unlimited life and possess ease of transferability of ownership. Employment taxes can be minimized. Although, a reasonable salary must be paid.

S Corporation

Corporations with fewer than 100 shareholders can elect to be taxed under Subchapter S of the IRC. With some exceptions, the “S Corp” is not subject to federal tax at the entity level. Profits and losses flow through to the shareholders, to be reported on their tax returns at their marginal tax rates. Some states tax “S Corps” at the entity level. Employment taxes can be minimized for owners receiving a salary. Although, the amount of the salary must be reasonable compared to the profits being generated by the entity.

Cashing out when changing employers: This act will cost you ordinary income taxes on your savings, as well as a 10% penalty. This should be an act of last resort only.

Doing nothing when changing employers: There are many reasons people leave their savings with former employers. Some fear of making a mistake, fear the amount of paper work involved, and some people are satisfied with the performance of their investments in their former plan. In general, by creating a new account and doing a direct transfer of your savings, you will have better investment options, you can consolidate your retirement savings accounts (easing your administrative burden), and better control the related expenses.

Not updating beneficiary designations: Because the inheritance rules regarding IRAs are so complex, it is imperative to make sure that your not creating a disaster for your loved ones by ignoring beneficiary designations.

Forgetting to invest the savings transferred: The last step is to choose the appropriate asset allocation after you have created the new account and transferred the savings. According to the Vanguard Group, many people forget to actually invest the savings once its been transferred. Instead, it sits in low-yielding money market accounts.

US Large Cap Stocks: Large US companies generate a significant portion (41% of revenues for the S & P 500 in 2005) of their revenue abroad. When the dollar is weak, international sales denominated in foreign currency translate into more revenue in dollars.

Foreign Stocks: US investors with a reasonable allocation to international stocks should get help as well. When the dollar declines in value, the value of international stocks goes up in dollar terms.

Foreign Bonds: Having a small portion of your allocation invested in bonds denominated in foreign currencies could provide a boost as well.

The key to compensating for the weak dollar is to maintain a globally well-diversified allocation. We recommend using no-load, low expense ratio index funds, or ETFs for those seeking broad international exposure.

Every year thousands of taxpayers overpay their income taxes because they use the standard deduction when itemizing deductions would be more advantageous. The causes are bad record keeping and simply not knowing or understanding the law. What follows is a basic review of what expenses qualify:

Taxes: State and local income taxes, real estate taxes, and personal property taxes are all deductible. Federal taxes, social security tax, and sales tax are not deductible.

Medical Expenses: You can deduct unreimbursed expenses for you, your spouse, and your dependents to the extent they exceed 7.5% of your adjusted gross income (AGI). This includes expenses for doctors, dentists, hospital care, prescriptions, nursing services, and medical aids. Also included are, insurance premiums, long term care premiums (within limits), and transportation and lodging.

Interest Expense: You can deduct interest paid on your primary residence and one second home. Also included are, first and second mortgages up to $1 million and home equity loans up to $100,000. Points are generally deductible and points incurred to refinance are amortized over the term of the loan. Interest paid on money used to acquire investments are deductible within certain limits.

Contributions: Donations to qualified organizations are deductible to the extent you receive no benefit in return. The organizations include churches, schools, libraries, and qualified charities. You can make donations in cash, check, or credit card. You can also deduct the fair market value of property other than cash. You must keep detailed records for donations of property other than cash, moreover you need a receipt for cash donations of $250 or more. All organizations must be located within the USA.

Casualty and Theft Losses: Losses from a fire, theft, or disaster are deductible within certain limits.

Miscellaneous Deductions: Included are certain unreimbursed employee expenses, investment expenses, gambling losses, and tax planning and tax preparation fees. Most of these expenses are subject to a 2% AGI floor.

To benefit the most, an awareness of the deductions that apply to you and good records are very important. If you have questions, please contact us.

In General: Defer income and accelerate deductions, harvest tax losses, maximize retirement plan contributions, avoid tax underpayments through withholding and estimated payments, and consider your exposure to the alternative minimum tax.

Car Donations: If you itemize your deductions you can donate a car (see previously featured article) to a qualified charity and deduct the fair market value of the car. Beginning in 2005, if you donate a car valued at more than $500 and the charity sells the car, you may only claim a deduction for the amount the charity receives, not the amount that you determine to be the fair market value.

Sales Tax Deduction: As a result of new tax legislation for 2004 and 2005, if you itemize your deductions, you can deduct the greater of either your state and local income taxes or your state and local sales taxes, but not both. This change will primarily benefit people in states with no state and local income taxes. Although, this change may even be advantageous for people who live in a low tax state or for people who have purchased big ticket items.

Year-End Donations: If you are planning a year-end donation to your favorite charity, consider giving shares of publicly traded stock or mutual fund shares that have substantially increased in value over the years. Provided you have owned the shares more than one year on the date of the donation, you can deduct the fair market value and not have to recognize capital gain on the increase in value on your Form 1040. Also, if you are considering donating cash but will not have the money until next year, charge your gift to a credit card this year. As a result, your donation is deductible this year even though you do not pay your credit card debt until next year.

Here is a three-step process that will enable you to review your overall tax situation during the last few months of this year so you can minimize any potential threat of underpayment penalties that may arise.

Tax Tips #1: Avoiding underpayment penalties

You can be assessed for underpayment penalties if your total tax due is $1,000. or more when you file your tax return. However, there are ‘safe-harbors” that protect you against penalties even if the tax you owe is $1,000. or more:

• If your withholdings and estimated payments are at least 90% of the current year’s tax liability, you will not be subject to any penalties, provided you pay the difference by April 15 of the subsequent year.
• If your withholdings and estimated payments are at least equal to last year’s tax liability you will not be subject to any penalties, with one exception: If your adjusted gross income is in excess of $150,000., you must pay 112% of the prior year’s tax liability in order to qualify for the “safe harbor.” This “safe-harbor” can be very advantageous for people who are experiencing a dramatic increase in income from the prior year. Even if your tax liability is two to three times greater in the current year you will be protected from penalties. You must pay the remaining tax you owe by April 15 of the subsequent year. In essence, you are receiving a short-term interest free loan from the federal government.

Tax Tips #2: It pays to plan

Individuals and business owners are not always aware that as the year progresses, they are accumulating a significant tax liability. If you are incurring a tax liability not subject to withholding throughout the year, you must make quarterly estimated payments to avoid the penalties. For calendar year taxpayers, the quarterly payments are due on April 15, June 15, September 15, and January 15 of the subsequent year. Business owners who are incorporated face similar rules. For calendar year corporations, the payments are due on April 15, June 15, September 15, and December 15. For fiscal year corporations, the payments are due on the 15th day of the fourth month, sixth month, ninth month, and twelfth month.

Tax Tips #3: Use the withholding rules to your advantage

You can compensate for earlier underpayments during the current year by adjusting your withholdings for the last few months of the year. The IRS considers withheld payroll taxes as being paid equally throughout the year, in spite of when actually withheld. In the case where your additional withholdings occur during the last few months of the year, bringing your total withholdings within the “safe-harbor” provisions, you will be able to avoid the underpayment penalties.