Do Business Well

If the company needs more money, you can lend your own funds to the corporation. The interest you earn is deductible to the company. Later you can pay back the loan. Of course, this principal passes back to you without tax. If you had capitalized the corporation at a higher level instead of using this loan technique, you would not have received tax-advantaged interest. Additionally, if you wanted to take out your original capital it might be seen as a dividend. In any case it would require the transfer of stock that would reduce your ownership if there was more than one owner.

The corporation can also lend you money. All these loans need to be clearly documented, and the company must charge you reasonable interest. However, once again you have been able to take some of the retained earnings out of the company without being taxed.

In many cases, the very small business is better off with a “Sub S” corporation, so called because it falls under Subsection S in the federal tax code. This form combines the advantages of a corporation with those of a partnership.

As long as the owners follow the rules of the federal tax code and their local state corporation code, the company will receive all the benefits of limited exposure offered to the “C” corporation. “Sub S” companies may also take advantage of some of the tax- advantaged pension, profit-sharing, and retirement plans enjoyed by a “C” corp. Others are not available.

The exciting part of the “Sub S” is the elimination of double taxation. In this form, a company passes through its earnings or losses to its owners. The corporation itself pays no taxes. (Actually, some states have a special tax for “Sub S” companies.)

Businesses that are expecting losses often use this form so that the owners can write off these losses. This is not possible in a “C” corp. If you have ten owners holding 10 percent each, and the company loses $100,000, each owner can write off $10,000 (as long as they have invested at least $10,000).

Be careful, however. If you have stockholders, or even if you are the only stockholder, a profit will result in a taxable event for all the owners. This is true whether or not the company pays out any cash (called distributions in a “Sub S”). For instance, if the company above makes $100,000, each shareholder will have $10,000 in regular income for that tax period. If he pays 25 percent tax, he wwill owe $2,500. If the company doesn’t pay out at least that amount, the taxpayer ill still owe it … and will have to pay it out of pocket.

It’s possible to switch your enterprise type. You can do so almost as often as you wish. Of course, each change means costs in money, time, and paperwork. It’s not uncommon for a company to start out as a simple sole proprietorship with commingled bank accounts and assets. As the business grows, it may move to separate its affairs from those of its owner. Down the road there may be a need for a working and/or financial partner, at which time the partnership form may be used.

As the company becomes successful and begins to accumulate assets, the partners may feel it is time to incorporate. They might start out as a “C” corporation, but later desire the tax benefits of the “Sub S.”

Unless you are a tax expert, you should probably get some advice from a CPA or an attorney as to which enterprise form best meets your needs now. You will also want to ask that question again from time to time as your business grows and changes.

Add to your business plan the enterprise type that you will use, the reasons for so choosing, your planned initial capital, and a list of partners or shareholders, if any.

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You can capitalize the company with the minimum amount you believe is “reasonable.”

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