Federal Taxation Class, Research Paper Example

There exist two types of corporations. A corporationtype C is levied taxation at a double rate. The corporation type C is responsible for taxes and the individuals are responsible in the circumstance of a corporation. A corporation type S pays only one level of taxation. In the situation in which John, Mark and Penelope are involved, it would be optimal for them to form a corporation. The business owners are responsible for the taxes (Tirole, 2010).

This situation is less expensive than a corporation type C. The corporationtype S isrestrictedto one level of taxation and they are only permitted to emit one hundred shares. The corporation type C has unlimited potential for the issuance of shares. The corporations type C and S would be more attractive to investors if John, Mark and Penelope wished to attract investors. The benefits of a corporation type C and a corporationtype S is that should one of the partners leave, the corporation would continue as an entity (Tirole, 2010).

A  LLC is another option which John, Mark and Penelope may wish to explore. The LLC is less expensive than forming a corporation. As the business increases in size, the business may be modified to a LLC condition. The benefits of a LLC are that the personal assets of the owners cannot be attached in the circumstance of adverse creditor action against the business. The assets of the company in a LLC, corporation type C and S are vulnerable to creditor actions. The disadvantage is that if one of the partners leaves the LLC, it may not continue as an entity (Tirole, 2010).

The corporation type S would be the optimal situation for John, Mark and Penelope in fulfilling their desire to reduce their tax liability. The corporation type S enables the members to pass the losses which are incurred by the corporation on their personal income taxes. This implies that any business related expenses or losses would be passed on to the owners in order to formulate tax deductions.  This would be the tax situation which would be the most suitable situation for John, Mark and Penelope. This feature could substantially minimize the tax burden which would be experienced by John, Mark and Penelope (Weitman, 2011).

The proportion of the profits and losses incurred by the corporation would be proportional to their percentage of the ownership of the total number of shares emitted.  The profits realized and the losses incurred by the corporation could be reported on each member’s tax return (Weitman, 2011).

The taxation law Section 351 states that there may be tax free transfer of property and cash to the corporation.  Services are exempt from the tax free status. Subsequent to the transfer of property or cash, the shareholder(s) who made the contribution would have control of the corporation type S. This aspect implies that the contributing member be in control of 80% of the stock and possess 80% of the voting authorities in the corporation type S (Daly & Quinn, 2013).

If John, Mark and Penelope contribute cash and property in conjunction, this may be may be perceived as a solitary transaction which was conducted in order to form and capitalize the corporation type S.  If the property of cash is contributed in order to the corporation type S to incur a long term debt in its repayment, it does not conform to the rules of tax exemption delineated by tax law Section 351 with regards to tax exempt contributions (Daly & Quinn, 2013).

The services which would be contributed by John, Mark and Penelope are taxed by the 80% rule. The services must be contributed with property which is valued at 10% of the total transaction. The contributor would be taxed on the services as compensation revenue (Daly & Quinn, 2013).

The corporation type S is structured in such a manner that the profits andlosses are passed to the stakeholders. The corporation type S has no federal tax which is levied against its revenue. There are employment taxes, built in taxes and passive income taxes (i.e., interest on fundsdeposited in a money market or CD account). The corporation would also be liable for taxes on earnings on investments (Mancuso, 2013).

John, Mark and Penelope derive benefit by the corporation type S making payments to them in the form of dividends or payments for services rendered. This is preferred in lieu of a salary which would be subject to employment taxes.  This strategy enables the minimization of income taxes by John, Mark and Penelope. This aspect has the characteristic of distributing cash to the owners and does not modify John, Mark and Penelope’s personal income which would subject to employment taxes if they were to be salaried employees of the corporation. The IRS has addressed this situation in Revenue Ruling 74- 44 (Graham & Smart, 2011).

In the scenario of the IRS suspecting that dividend payment are salaries, this suspicion would be due to the attribute of the payments being disbursed regularly in the same amounts as if they were salaries (Graham & Smart, 2011).

Many corporations prefer to distribute profits instead of wages. This approach enables the avoidance of employment taxes. In the distribution of profits, theshareholders pay taxes upon the profits which are received as the stock which has been emitted by the corporation earns value. In the scenario of the corporation type S paying profits it is detailed as a return of basis (Verma, 2009).

John, Mark and Penelope will calculate their potential dividend in the corporate entity as a function of the percentage of shares which are held by each member and the earnings and profits of the shares of the corporation type S. The losses which are incurred by the shares which are held by John, Mark and Penelope may be written off on their personal income taxes as a loss (Clayman et al., 2011).

The liability which would be incurred to personal assets by John, Mark and Penelope in the scenario n of adverse creditor action would be none in the circumstance of a corporation type S. This is one of the benefits of the corporation type S. The assets which are held by the corporation type could be attached by creditors and other entities which are seeking restitution of business debt incurred by the operation of the corporation type S. The personal assets held by John, Mark and Penelope would have no exposure to the liabilities which are incurred by the corporation type S (Clayman et al., 2011; Tirole, 2010).

References

Clayman, M. R., Fridson, M. S., & Troughton, G. H. (2011). Corporate finance: A practical approach. New York: John Wiley & Sons.

Daly, F. W. & Quinn, J. A. (2013). Tax savvy for small business. Berkeley, CA: Nolo Publications.

Graham, J. & Smart, S. (2011). Introduction to corporate finance: What companies do. Belmont, CA: Cengage Learning.

Mancuso, A. (2013). How to form your own California Corporation. Berkeley, CA: Nolo Publications.

Tirole, J. (2010). The theory of corporate finance. Princeton, N.J.: Princeton University Press.

Verma, K. K. (2009). Corporate accounting. New Delhi: Excel Books.

Weitman, B. (2012). J. K. Lasser’s small business  taxes 2012: Your complete guide to a better bottom line. Hoboken, N. J.: John Wiley & Sons, Inc.