Setting Up A Business – Tax Guidelines & Strategies

Here’s a handy comparison of the types of business entities. In setting up a business we strongly urge you to consult both your accountant and attorney as to the best structure for you and your business.

Types of Business Entities

A. Proprietorship

B. Partnership

1. Limited

2. General

C. Corporation

1.C Corporation

2. S Corporation

D. Limited Liability Company (LLC)

Pros and Cons

A. Sole Proprietorship

1. Advantages

a) ease of organization

b) Ease of investment or withdrawal of cash or assets

2. Disadvantages

a) Unlimited liability

b) Can not use fiscal year

B. Partnership

1. Advantages

a) Fairly easy to set up organization

b) Any income or loss is taxed directly to the Partners

c) Ease of investment or withdrawal of cash or assets

2. Disadvantages

a) General Partner has unlimited liability

b) Generally can not use fiscal year

C. “C” Corporation

1. Advantages

a) can accumulate income at the low corporate rate

b) Flexibility in choosing fiscal year

c) the fringe benefits of the shareholders are fully deductible

d) can be part of an affiliated group

2. Disadvantages

a) Possibility of double taxation

b) Cannot utilize cash method if gross income is above $5 million

c) Losses can’t be used by shareholders

d) The top corporate rate is higher than the top individual rate

D. “S” Corporation

1. Advantages

a) Generally no tax at the corporate level

b) Generally no double taxation

c) Never a Personal Service Corporation

d) No cash basis limitation

e) Losses pass through to shareholders

2. Disadvantages

a) Generally cannot use fiscal year

b) Certain fringe benefits not deductible for 2% shareholders

c) Can’t be part of affiliated group

d) Can’t have greater than 35 shareholders or other than certain types of shareholders

E. Limited Liability Company (LLC)

1. Advantages

a) Limited liability similar to a corporation

b) Taxed like a partnership

2. Disadvantages

a) Must be Chartered by State

B) Taxed like a partnership

Revenue & Expense Recognition

The ordinary and necessary costs of doing business are allowable business expenses. Expenses are matched against business income to derive net income or loss from the operations. Classifications of expenses include direct costs such as inventories, supplies and labor and indirect costs such as rent, insurance, utilities or administration. There are three types of basis for revenue and expense recognition:

Cash Basis: The focus is on cash collected and expenses disbursed. Accounts receivable and accounts payable are not factored into income expenses as they are not yet collected or paid.

Accrual Basis: All transactions are accounted for and including in the accounting records for the period involved. These records include all transactions of the business which are consummated with another party and include items that are not yet collected or paid for during the given period.

Modified Cash/Accrual: This hybrid method uses certain aspects of both the cash and accrual methods.

Depreciation and Accounting for Assets

Depreciation is defines as the systematic and rational allocation of an asset’s cost over its useful life. Components of an asset’s cost include the actual price paid to purchase or manufacture it including all related costs to put it in service such as freight and installation.

Companies have a choice as to the type of method(s) used to figure depreciation for accounting purposes. These methods include: straight-line, declining balance, sum-of-the-years digits or any reasonable method that allocates cost to use for the period involved. The life of an asset is also subjective for book purposes. The taxpayer may assign any reasonable life based on the asset and its expected use.

The taxing authorities dictate and life and method used for tax purposes. These methods and lives can differ between Federal and State.

Grimes, McGovern & Associates provides expert advice during all phases of a transaction. Contact us today for a confidential consultation: John McGovern, CEO, [email protected], (917) 881-6563.