Memo 1

Memo
To: Mr. Bob Jones
From: M-Jasmine Company
Cc:
Date: 29th June, 2019.
Re: Type of Business to Settle For
For the purposes of tax and liability issues, I’d recommend that the client settles for S
corporation for his investment. This is because the S corporations have limited tax liabilities as it
imposes only a single level of taxation on the shareholders. He should avoid C corporations
because they are subjected to double taxation and therefore implies higher tax liabilities. S
corporation reduces tax liabilities in accordance with Section 26 U.S. Code § 1361, while at the
same time benefits small business owners it shields them from additional liabilities. The
liabilities of the corporation such as debts are not considered that of its owner, therefore, the
owner’s personal assets are not put at risk. Corporations can also retain its profits without the
owner having to pay tax on them. Corporations are also more able to raise money by selling
stocks and continue indefinitely. With the S corporation, the client, as a shareholder will be paid
dividends. His share of income, deductions, losses, and credits will be entered in the Schedule K-
1 form that he will then use to file returns (Entrepreneur, 2019).
Bob should choose a business entity that has limited liability protection. This is because
he will not be personally responsible for the debts and liabilities of the business as the owner.
Instead, the business (S corporation in this case), will be responsible for its debts and liabilities.
Creditors cannot therefore pursue Bob’s assets to repay the debts. He will therefore be shielded
from putting his assets at risk. He will also be shielded from double taxation by the pass-through
taxation method. In this case, no income tax will be paid at the business level. Instead, the profits
and losses made by the business will be passed-through to Bob’s personal tax returns and
reported and paid at the individual level (Kliwer, 2019).
As an S corporation, Bob’s business will not have to pay taxes at the corporate level. All
the business income and losses will be passed through and reported in the personal income tax
returns of the shareholders. This will be helpful at the startup level as the business will not be at
risk of being classified as a personal holding company. As a shareholder of an S corporation,
Bob can also be an employee of the business and receive salary, which will be great during his
retirement. He will also be able to receive dividends from the corporation and other tax-free
distributions to the extent of his investment in the corporation. Distributions as salary or
dividends will help Bob as the owner-operator reduce his self-employment tax liability, while at
the same time still generating business-expense and wages-paid deductions for the corporation.
The economic impact on Bob’s financial situation can vary significantly depending on
the structure of the used car business he decides to adopt. C Corporations are for instance treated
as separate entities from the owners for taxation purposes and therefore, if Bob chooses this type
of business, it will be taxed separately and therefore he will have to be subjected to double
taxation. Sole proprietorship, partnership and S Corporations on the other hand will result in Bob
file all the income and losses made by the business on his personal income tax returns as
required by IRC Section 1366.
Bob’s daughter can have ownership interest, and S corporation makes the transfer of
ownership easier. S corporations are structured to ensure easier transfer of ownership to ensure
continuity in business (Kliwer, 2019).

S corporation advantages
The advantages of an S corporation often outweigh any perceived disadvantages. The
S corporation structure can be especially beneficial when it comes time to transfer
ownership or discontinue the business. These advantages are typically unavailable to
sole proprietorships and general partnerships. S corporation advantages include:
 Protected assets. An S corporation protects the personal assets of its
shareholders. Absent an express personal guarantee, a shareholder is not
personally responsible for the business debts and liabilities of the corporation.
Creditors cannot pursue the personal assets (house, bank accounts, etc.) of the
shareholders to pay business debts. In a sole proprietorship or general partnership,
owners and the business are legally considered the same—leaving personal assets
vulnerable.
 Pass-through taxation. An S corporation does not pay federal taxes at the
corporate level. (Most—but not all—states follow the federal rules. View the
Ongoing Corporation Requirements page of our state guides to see if your state
recognizes the federal S corporation election.) Any business income or loss is
"passed through" to shareholders who report it on their personal income tax returns.
This means that business losses can offset other income on the shareholders’ tax
returns. This can be extremely helpful in the startup phase of a new business. (A
corporation that does not elect S corporation status and accumulates passive
income is at risk of being classified as a personal holding company.)
 Tax-favorable characterization of income. S corporation shareholders can be
employees of the business and draw salaries as employees. They can also receive
dividends from the corporation, as well as other distributions that are tax-free to the
extent of their investment in the corporation. A reasonable characterization of
distributions as salary or dividends can help the owner-operator reduce self-
employment tax liability, while still generating business-expense and wages-paid
deductions for the corporation.
 Straightforward transfer of ownership. Interests in an S corporation can be freely
transferred without triggering adverse tax consequences. (In a partnership or
an LLC, the transfer of more than a 50-percent interest can trigger the termination
of the entity.) The S corporation does not need to make adjustments
to property basis or comply with complicated accounting rules when an ownership
interest is transferred.
 Cash method of accounting. Corporations must use the accrual method of
accounting unless they are considered to be small corporations. (A small
corporation has gross receipts of $5,000,000 or less.) S corporations, however,
usually don't have to use the accrual method unless they have inventory.
 Heightened credibility. Operating as an S corporation may help a new business
establish credibility with potential customers, employees, vendors and partners
because they see the owners have made a formal commitment to their business.
References
Entrepreneur. (2019). Choose Your Business Structure. Retrieved from
https://www.entrepreneur.com/article/38822
Kliwer, W. (2019). Compare S Corporation vs LLC. Retrieved from
https://www.bizfilings.com/toolkit/research-topics/incorporating-your-business/s-corp-vs-llc

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Memo

To: Mr. Bob Jones

From: M-Jasmine Company

Date: 29th June, 2019.

Re: Type of Business to Settle For

1 form that he will then use to file returns (Entrepreneur, 2019).

reported and paid at the individual level (Kliwer, 2019).

risk of being classified as a personal holding company. As a shareholder of an S corporation,

distributions to the extent of his investment in the corporation. Distributions as salary or

required by IRC Section 1366.

continuity in business (Kliwer, 2019).

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