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.That s why it is wise to check out anyone with whom you plan toenter into a general partnership.LIMITED PARTNERSHIPSIn contrast, limited partners are liable only to the extent of their investment inthe business and their obligation to make further investments.Limited partnerscannot take an active part in the management of the partnership.A limited part-nership must have at least one general partner (which could be a corporation)but can have as many limited partners as it wants.Limited partnerships are pop-ular for financing things like movies and real estate developments.LIMITED LIABILITY PARTNERSHIPS (LLPS)A type of entity that has only recently been authorized by state statutes is theLLP.It is just like a general partnership except for one important difference: Inmost states, partners in a registered LLP are jointly and severally liable forcommercial partnership debt, but are not personally liable for the malpracticeand torts of their partners.In some states, LLP partners are granted completelimited liability.In 1994, all of the then Big Six accounting firms (now BigFour) changed from general partnerships to LLPs.LIMITED LIABILITY COMPANIES (LLCS)An LCC combines partnership tax treatment with limited personal liabilityfor all the owners of the entity.All states have passed legislation permittingthe establishment of LLCs in some form.More details are provided later inthe chapter.C CorporationsWhen you form a corporation, you create a separate tax-paying entity.Unlikesole proprietorships and partnerships, income earned by a regular corporationis taxed at corporate rates, unless the corporate shareholders elect to be anS corporation.Regular corporations are called C corporations because Sub-chapter C of Chapter One of the Internal Revenue Code is where you find allthe general tax rules affecting corporations and their shareholders.The rulesfor S corporations are found in you guessed it! Subchapter S.CHOICES FOR BUSINESS ORGANIZATION46Forming a CorporationThis is a fairly straightforward process.It involves submitting articles of incorpo-ration to the Secretary of State of the state in which you want to incorporate.Thearticles contain the name and purpose of the corporation, the name of a regis-tered agent in the state where mail can be sent, the name of the incorporator,the number of shares authorized, and the classes of stock authorized.The stateof incorporation does not have to be the state in which you will be conductingbusiness.For example, a lot of businesses incorporate in the state of Delawarebecause of that state s flexible, well-developed, and corporate friendly laws.Be-fore you jump into this, however, read the rest of this chapter.Also, be sure tocheck the franchise tax and filing requirements for the state in which you chooseto incorporate.You might find that your small business will pay a lot of extramoney to the state just for being a corporation.If you hire a lawyer to file the articles of incorporation, the lawyer will prob-ably do what lawyers do best charge you a lot of money.Since incorporating isa straightforward process, you might want to save on the lawyer fees and just dothe incorporation yourself.The Secretary of State s office in most states willsend you a form Articles of Incorporation that allows you to simply fill in a fewblanks, pay a fee, and voilá! you re a corporation.On the other hand, you might still want to hire an attorney if you have ques-tions about which state of incorporation is best, the liability protectiongranted, and how to make an S election (discussed later).Also, if othershareholders are involved, considerations like buy-sellagreements come into play where legal advice might beNOTEcrucial.Taxable income ofcertain corporations,Reporting Taxable Incomesubstantially all theactivities of whichA C corporation reports taxable income on Form 1120involve the performance(U.S.Corporation Income Tax Return) or Form 1120-Aof services in the fields(the corporate short form), and pays tax on its taxable in-of health, law,come using the rate schedule for corporations.The topengineering,corporate tax rate imposed on C Corporations with in-architecture,come under $100,000 is 34 percent (qualified personalaccounting, actuarialservice corporations are subject to a flat tax rate of 35science, performingpercent) which is the same as the top individual rate inarts, or consulting2005.It may not be advantageous to be taxed as a corpo-( qualified personalration, however, because corporations have a two-tier taxservice corporations )structure.This means that if earnings are paid to anis taxed at a flat rate ofowner (shareholder) as a dividend, the money is taxed35 percent.once at the corporate level and again at the shareholderlevel.Therefore, you should carefully consider how theC CORPORATIONS47corporate tax regime will affect you before deciding to incorporate.Here arethe rates for corporations:CORPORATION INCOME TAX RATES FOR 2002TAXABLE INCOME OVER NOT OVER TAX RATE$0 $50,000 15%50,000 75,000 2575,000 100,000 34100,000 335,000 39335,000 10,000,000 3410,000,000 15,000,000 3515,000,000 18,333,333 3818,333,333.35Example 3.3Ed s Corporation files Form 1120, and reports taxable income of $50,000 afterpaying its shareholder-employee, Ed, his wages.The corporation pays corpo-rate income tax of $7,500.The balance of its taxable income, $42,500 is dis-tributed as a dividend to Ed.Ed is in the 35 percent bracket, but the maximumrate on corporate dividends is 15 percent; so Ed pays $6,375 on the dividend.The total income tax paid on the $50,000 of corporate earnings is $13,875($7,500 + $6,375).If Ed operated instead as a sole proprietorship, income taxon the $50,000 of income would be $17,500 ($50,000 × 35%).If Ed, in Example 3.3, was in a lower tax bracket, he might want the corpora-tion to pay him an additional $50,000 of wages.The corporation would havezero taxable income after wages, which would eliminate the double taxation.Wages are deductible by the corporation under Section 162 of the Code only ifthey are reasonable. If the IRS thinks Ed has received more in pay than hisservices are worth, the IRS will reclassify the money as a dividend and the re-classified amount will still be subject to the two-tier tax system.EMPLOYMENT TAXESEmployment taxes are another consideration in deciding how corporate earn-ings should be distributed.CHOICES FOR BUSINESS ORGANIZATION48A corporate shareholder pays social security and Medicare taxes only on com-pensation for services, not on dividends.If the shareholder is an employee, thecorporation and the employee each pay one half of these taxes, and the corpora-tion can deduct its half.Another look at Ed s situation is shown in Example 3.4.Example 3.4If Ed s Corporation in Example 3.3 used its $50,000 of taxable income as wageexpense, the corporation would have no taxable income, so it would not paycorporate income tax.However, the combined corporate/employee liability forSocial Security taxes on the additional wages to Ed would be as much as 15.3percent or as little as 2.9 percent
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