What would you suggest to the following: a client, Angie Zholee, comes to you an

Question

What would you suggest to the following: a client, Angie Zholee, comes to you and wants to know what she should do about organizing her business. She is a real estate agent, and will have losses of about $40,000 in the 1st year of business. However, starting in the 2nd year, she anticipates a large net profit, at least over $195,000. F wants liability protection, but she already pays for liability insurance. She is the only owner, but her 17-year-old twin kids are helping her. She files head of household, has no other income, and has $30,000 in itemized deductions. She lives in California, and she heard on the radio that if she sets up her business in Nevada, she can avoid the $800 minimum tax that California charges for all LLCs and corporations.

(1) What are the advantages and disadvantages of staying as a sole proprietorship? California's state income tax is 9.3%.

(2) What are the advantages and disadvantages of forming a C-corporation? California imposes an 8.4% corporate income tax on C-corporations.

Explanation / Answer

Advantages of Sole Proprietorship
Many sole proprietorships are one-owner businesses. An individual owns and operates the business and is responsible for all business transactions. He may or may not have any employees. He can close it, sell it or pass it down to his heirs at any time. A sole proprietor pays taxes as a part of his individual income tax filing. Some businesses may require licensing. However, the costs of obtaining a license for sole proprietors are substantially less than those for corporations. Start-up costs for sole proprietorship are very low.

The main disadvantage of sole proprietorships is the owner's personal liability for all debts incurred by the business. Creditors may come after an owner's personal assets if a small business is unable to cover debts. Sole proprietors may have difficulty obtaining business loans. Financial institutions are reluctant to lend to them as many small business loans go into default when companies struggle to stay afloat. While a sole proprietorship does not pay taxes, the owner may have to pay higher taxes as his profits increase. A sole proprietor may not deduct health insurance expenses when filing a tax return.

b) Here are some reasons not form a C corporation:

Liability protection: Because the C corporation is legally an entirely separate entity from the owners and shareholders, owners and shareholders cannot be held responsible for any debts of the C corporation or any lawsuits brought against it. In other words, your personal assets will not be affected by the actions of the corporation.

Attracting investors: A C corporation can sell stock or shares, either common or preferred -- and there’s no limit to the number of shareholders. If you ever plan to go public, you’ll also need to be structured as a C corporation. In addition, the C corporation form allows you to offer employees a stock option plan.

Taxes: Because the corporation is a separate entity, the profits and losses of the C corporation are retained for the corporation. Unless you or your shareholders receive dividends, you will not be taxed on the company’s income. Also in your favor, you can deduct business expenses and employee benefits in your tax filings

Lower tax rate: You also have the option of splitting profits and losses between the business and the owners to create an overall lower tax rate. Check with your accountant on the best way to do this for your situation

Perpetual existence: A C corporation will exist indefinitely, even if a shareholder or owner leaves, becomes disabled, dies, or sells off their shares

Here are some reasons not to form a C corporation:

Higher costs: Corporations pay a number of state and federal filing fees, and each state also has its own set of regulations. Dealing with these regulations may require the professional expense of an attorney or accountant.

Increased paperwork: Increased regulations and complex rules require a corporation to file a number of documents, including Articles of Incorporation, corporate bylaws, corporate minutes, certificates of good standing, and more.

Double taxation: Owners of the corporation pay a double tax on the earnings of the company, and shareholders must pay taxes on the dividends received. However, if the owners take a salary, the corporation is not required to pay tax on the earnings. The payments are considered a business expense.

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