Choosing the Wrong Form of Business Entity Can Be CostlyBy Peter C. Pappas, J.D., CPAProspective business owners often dismiss the choice of business entity as a mereformality. Far too many entrepreneurs choose the wrong entity at the outset,costing themselves and their businesses thousands of dollars. The business owner should consider all of the following forms of doing businessand their attendant tax consequences before selecting a business entity. The corporation Generally, there are two types of for-profit corporate forms of doing business:the "C" corporation and the "S" corporation. Both C and S corporations insulate small business owners from personal liabilityfor corporate debts. Thus, except in certain special cases, trade and judgmentcreditors of the corporation cannot recover damages against the owners of thecorporation.The corporate characteristic of limited liability is the major non-tax reasonsmall business owners choose the corporate form of doing business. The C corporation is a separate tax-paying entity liable for the payment of incometax on the taxable income of the business. The owners of a C corporation aregenerally not required to pay tax on the undistributed earnings of the Ccorporation. However, C corporation losses cannot be used by the owners of thecorporation to offset their personal taxable income.The major disadvantage of a C corporation is that the distribution of profits toits shareholders results in what is known as "double taxation." The profits havebeen taxed once at the corporate level and are taxed again at the individualshareholder's level. Thus, the C corporation is generally advisable for thosesmall businesses that intend to retain profits in the business for futureexpansion and growth. Conversely, the S corporation is not a separate income tax-paying entity. Taxableincome is calculated at the corporate level and then "passed through" to theowners and included on their individual income tax returns regardless of whethersuch income is actually distributed to them.Subject to certain basis and at-risk limitations, S corporation losses may be usedby the owners to offset income included on their personal income tax returns. The big advantage of the S corporation is that it enables small business owners toavoid double taxation of corporate profits and allows them to use corporate lossesto offset personal taxable income. The intention of Congress in enacting the Scorporation laws was to provide small business owners with limited liabilityprotection without subjecting them to the burdensome double tax. Consequently, anS corporation may not have more than 50 shareholders and none of its shareholdersmay be nonresident aliens. Finally, Florida business owners gain an additional advantage by using the Scorporation form of business by avoiding the state's 5.5 percent C corporationincome tax. Because there is no personal income tax in Florida, S corporationearnings escape state tax altogether. The partnership
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