The Tax Attic with Jerry Coon – October 8, 2009

Jerry Coon, Enrolled Agent

Jerry Coon, Enrolled Agent

Advantages of partnerships, C corporations

There are a few things I would like to do before I ride off into the sunset—my bucket list of sorts. One of them is to drive a winged sprint car. I joke about that one maybe having to wait until my next life. But since I’m of the Reformed Church religious persuasion and we don’t fundamentally believe in reincarnation, the “next life” thing probably isn’t going to work. I don’t anticipate that my minister, Rick Tigchon, is going to preach a sermon on reincarnation being an option any time soon, either. It’s going to be done in this life or it won’t be done.

The reason I bring this up is Berlin Raceway held its annual Open Wheel Night on Sept. 26. A number of classes, including midgets and late models, raced. But the main attraction for me was the winged sprint cars. I love watching those guys race. You can tell the fast ones from their motor sound. Once they hit wide open, which is about one second after they stomp on the pedal, the fast ones never let off all the way around the track. They use their brakes and the bank of the track to slow the car in the corners, but you can tell from the motor sound that the foot is in fuel injectors all of the time.

One of the racers, Hank Lower, gives me hope that I will fulfill my dream of driving one of the sprint cars. Hank is an Indiana guy and he is 72 years old. Granted, he has been driving these cars most of his life, he is still competitively driving at age 72. He finished in the top ten in the feature event, which means he beat most of the kids in the race. Since I’m a whole lot younger than 72, there is plenty of time to get me strapped into a sprint car. I think I will go online tonight and see what’s available in the sprint car driving school arena. Maybe Hank gives lessons.

I want to continue with my series on the various business entities available to a person who is starting a business. Multi-member LLCs file a Form 1065, Partnership Tax Return. This form reports the income and expenses of the partnership. Each member of the partnership gets their percentage of the income or loss and separately reports deductions on a K-1.

One of the unique items about a partnership is that the income or loss and those separately reported deductions can be divvied up in any way that the members see fit. For example, my brother and I are the two members of Jerry’s Landscaping and Income Tax LLC. My brother put up all of the money to get the business started, but since he lives in Indiana and the business is located in Rockford, I perform all of the labor associated with the business. We can mutually agree to split the profit, and each report and tax taxes on one-half of that profit. His money and my brains and brawn could add up to an even split.

However, let’s say the first year of business was a loss because of the heavy start-up costs of advertising and buying equipment. We could mutually agree that since he put up all of the money, for the first year he gets to deduct 100% of the loss on his tax return. We could pick any percentage that we agree upon. Some of the items that are separately stated on the K-1 include the expensing of equipment and charitable contributions of the partnership. They are subject to the same agreement—we can split them up as we see fit. In the second year, the business does have a profit. What we agreed to in the first year does not affect the second year. Again, this profit can be allocated by percentage and by mutual agreement. This is one of the advantages of a partnership that is just not available to other types of business entities.

So far, we have discussed sole proprietorships (Schedule C businesses) and single-member LLCs, and Form 1065 Partnerships and multi-member LLCs. The next type of entity that can be chosen is a corporation.

There are two types of corporations to discuss. The first type is called a C Corp. The “C” ties back to Subchapter C of the Internal Revenue Code of 1954—the date of the last time the Internal Revenue Code was totally revised. We have had plenty of partial revisions since 1954, but not a total revision. It might be about time to update it.

All corporations of the variety that we deal with start out as C Corps. The first step in forming a C Corp is to file “Articles of Incorporation” with the State of Michigan. This protects the corporation’s name within all of Michigan. Once this process is in motion, the applicant applies to the Internal Revenue Service for a Federal Employer Identification Number (FEIN). All corporations must have an FEIN. All people have nine-digit Social Security Numbers. All non-person entities, such as corporations, are issued a nine-digit FEIN at the time of formation.

Similar to the LLC, the corporation is formed at the state level. However, the IRS does recognize corporations as entities. The LLC is a disregarded entity, while the corporation is not disregarded. A regular C corporation files an income tax return on a Form 1120. The corporation pays taxes on its profits or deducts its losses, but it is self-contained. The profit or loss is not passed on to the shareholders. Examples of 1120 C corporations would be General Motors, Wolverine World Wide, and General Electric.

The next type of corporation to discuss is a Subchapter S corporation. As you guessed, the rules for Subchapter S are spelled out in Subchapter S of the 1954 Internal Revenue Code. That subchapter probably could use some revisiting, too.

My next week’s article will discuss Subchapter S rules. They are interesting and actually more applicable to a person starting up a business than the C Corp rules. This is Jerry Coon signing off.

Jerry Coon is an Enrolled Agent. He owns
Action Tax Service on Northland Drive in Rockford.
His telephone number is (616) 866-4704.
His e-mail address is jcoon@actiontaxservice.com.

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