What type of business should I be? Should I form a limited liability company (LLC) or a corporation? These are common questions business owners may ask their business attorney, and they are good questions. It is important for a business owner to understand their options when forming businesses and the implications. Choice of entity is a very important question for any business and has implications from the formation of the business, during the operation of the business and when the business or business interests are sold or transferred. The article below has been drafted by a Denver business attorney at The McGuire Law Firm to begin the discussion on choice of entity and provide a little background as to when pass through entities began to become a little more attractive to the business owner as opposed to the C corporation.
In many ways the 1986 act reduced the reasons and advantages for businesses to operate as a C corporation. The General Utilities doctrine was repealed and thus made it more difficult for a C corporation to pass earnings and unrealized appreciation to the corporate shareholders without creating two levels of tax (double taxation) at the corporate and individual shareholder levels. The double taxation of a C corporation does have some relief given that qualified dividends to non-corporate taxpayers will be taxed as capital gains as opposed to ordinary income. See Internal Revenue Code Section 1(h)(11). It is also important to note that the American Taxpayer Relief Act of 2012 made the preferential capital gains treatment of qualified dividends permanent, but raised the top capital gains rate. Taxpayers in the 39.6 bracket have qualified dividends taxed at 20% as opposed to 15%. Higher earning taxpayers must also consider the 3.8% net investment income tax under Internal Revenue Code Section 1411. Thus, one could consider the rate to be closer to 24% on qualified dividends for higher earning taxpayers.
Another potential disadvantage to a C corporation was/is that for the first time, the highest marginal income tax rates for individuals was less than the highest corporate income tax rates, which made pass through entities such as an LLC or S corporation more attractive. Later, the top marginal individual bracket was increased, so the rate differential was not apparent for too long of a time.
The 1986 act also replaced the corporate add on minimum tax with AMT or alternative minimum taxable income on C corporations after 1989. One provision was that the alternative minimum taxable income of a corporation is increased by 75% of any excess of the adjusted current earnings of the corporation over the alternative taxable minimum income. See IRC Section 56(c)(1).
Given certain detriments of operating a business as a C corporation, many new businesses considered and did form pass through entities such as an LLC or an S corporation as their choice of entity. These business entities may be even more beneficial if start up losses are expected. Existing corporations should at least consider restructuring to avoid potential double taxation.
A Denver business attorney at The McGuire Law Firm can assist you with your choice of entity, the formation of your business, legal issues & work as your business operates and the eventual sale and transfer of your business assets or interest.
Contact The McGuire Law Firm to schedule your free consultation with a Denver Business Attorney.