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Choosing the right business structure for your enterprise is a crucial decision. It has long-lasting ramifications, as it sets the path for the future in terms of operations, management, legal, and tax issues. Proper research should be done before you take your pick.

There are several organizational forms that businesses can choose from, including sole proprietorship, partnership, limited liability company (LLC), corporation, or an S corporation.

S Corporation is a variation of a corporation within Subchapter S of Chapter 1 of the Internal Revenue Code. Essentially, an S corp is any business that chooses to pass corporate income, losses, deductions, and credit through shareholders for federal tax purposes, with the benefit of limited liability and relief from “double taxation.” Some 30 million business owners include business profits on their personal income tax returns.

To be an S Corporation, your business first needs to be set up as a corporation by filling and submitting documents like the Articles of Incorporation or Certificate of incorporation to the appropriate government authority, along with the applicable fee.

Once the incorporation process is complete, all shareholders must sign and submit Form 2553 to be granted the S Corporation designation. From there, taxes are handled by the corporation’s partners on their individual returns.

To qualify:

• Shareholders may only be individuals, certain trusts, estates, and certain exempt organizations (such as a 501(c)(3) nonprofit). Shareholders may not be partnerships or corporations.
• Shareholders must be US citizens or residents.
• The business may have no more than 100 shareholders.
• The business may only have one class of stock (if stock is issued).
• The business profits and losses may only be allocated in proportion to each owner’s interest in the business.
• The business must not be an “ineligible corporation” such as an insurance company subject to subchapter L, domestic international sales corporation (DISC), or possession corporation under section 585.
• All shareholders must consent to the election.

According to Internal Revenue Service (IRS), to qualify for S corporation status, the corporation must meet the following requirements:

• Be domiciled in the United States
• Have only allowable shareholders, which may include individuals, certain trusts, and estates, and cannot include partnerships, corporations, or non-resident alien shareholders
• Have 100 or fewer shareholders
• Have just one class of stock
• Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations, which are forbidden the S corp structure)

More Advantages of an S-Corp Structure

Independent Life

Unlike a sole proprietorship or LLC (LLC without necessary inclusions in its operating agreement) where the life of the business is linked to the owner’s life or exit from business, an S Corporation has an independent life span. Its longevity is not dependent on shareholders, whether they depart or stay, thus making it relatively easy to do business and look at long-term goals and growth.

Self-Employment Tax

Employing an S Corporation structure can lower the self-employment tax. The taxable business income can be split into two components salary and distribution. Here, only the salary component attracts the self-employment tax, thus reducing the overall tax liability. While in the case of a sole proprietorship, partnership, or LLC, the self-employment tax is applicable on the entire net business income.

The second component of the income comes to the shareholder (owner) as distribution, which is not taxed. By making a “reasonable” division between the two components, there can be a substantial amount of tax savings. It’s considered good to draw approximately 60% of the company’s income as salary since any unreasonable division could be construed as an attempt to avoid taxes.

Protective Shield

Personal assets of shareholders are protected by the structure of an S Corp. No shareholder is personally responsible for the liabilities and debts of the business. Creditors have no claim on the personal assets of shareholders in order to settle business debt, whereas personal assets are vulnerable under sole proprietorships or partnerships.

Transfer of Ownership

It’s relatively easy to transfer interest in an S Corporation as compared to other forms of business entities. The sale can be structured in two ways:

• An outright sale, where the buyer makes the purchase in one go and there is an immediate transfer of ownership.
• A gradual sale, where the purchase is done over a period of time. Whichever way is chosen, the transfer of ownership is facilitated through a written sales agreement that formalizes the whole process.

As a pass-through entity, S corporations distribute their earnings through the payment of dividends to shareholders, which are only taxed at the shareholder level. Income is taxed only once, when the income is earned by the S corporation, whether the income is reinvested or distributed. Unlike partnerships, S corporations are not subject to either the accumulated earnings tax or the personal holding company tax. Earnings are accumulated in a retained earnings account, but they are not considered earnings and profits (E&P), since the income is taxed on the individual returns of the shareholders. Every share of stock gives the holder an equal right to the retained earnings as any other share. So, any rights to the distribution of retained earnings are represented by the number of shares held by a stockholder, not on any agreement, as in a partnership.

A shareholder’s basis in the stock of the S corporation initially depends on the amount of capital contributed by the shareholder. However, because the S corporation is a pass-through entity, the shareholder’s basis changes every year, depending on income, losses, and other separately stated items. Initial basis is determined by the amount of cash paid to the S corporation for shares and by the fair market value of any property contributed to the corporation. If the stock was received as a gift, then the basis is the carryover basis of the donor; if the stock was inherited, then it receives a stepped-up basis. If the S corporation previously operated as a C corporation before the conversion, then the stock basis will equal the basis in the C corporation stock at the time of the conversion.

Capital Gain = (Note Balance – Debt Basis) ÷ Note Balance × Repayment Amount

Return of Capital = Repayment Amount – Portion Treated As Capital Gain

A shareholder’s stock basis is increased by:

• Ordinary income
• Separately stated income items
• Tax-exempt income
• Excess depletion.

Stock basis is decreased, but not below by:

• Ordinary loss
• Separately stated loss items
• Nondeductible expenses
• Non-dividend distributions
• If applicable, depletion for oil and gas

Dividend distributions do not reduce basis because it is just the distribution of net income, which is taxed to the shareholder, whether distributed or not. Only non-dividend distributions reduce stock basis, which is reported on Form K-1 (Form 1120S), Shareholder’s Share of Income, Deductions, Credits, etc.; dividend distributions are reported on Form 1099-DIV, Dividends and Distributions. The Schedule K-1 does not show how much of the distribution is taxable, because only the shareholder can determine that based on his basis.

The tax on the distribution and the deductibility of a loss depends on stock basis. However, the stock basis must be adjusted by flow-through items from the S corporation in a particular order:

1. Basis is increased for income items and excess depletion
2. Then decreased for:

• Distributions
• Nondeductible, non-capital expenses and depletion
• Loss and deduction items

The shareholder’s basis in stock is always reduced by current year losses, even if such losses would be limited by at-risk or passive activity rules. In contrast to losses and deductions, the tax benefits of tax credits are not limited by basis. However, they may change basis, depending on the specific type of credit.

Loss and deduction items reduces stock basis 1st, but cannot reduce the basis below 0. If the shareholder also has a debt basis in the corporation, then that basis is reduced by loss and deduction items that could not be used to reduce the stock basis. However, if the shareholder has no debt basis in the corporation or the debt basis is reduced to 0, then the total of loss and deduction items exceeding the basis is suspended and can be carried forward indefinitely. Moreover, if the S corporation repays the debt when the shareholder has a reduced basis, then the amount of the repayment exceeding the basis to the shareholder is taxable to the shareholder. Any suspended loss and deduction items can be carried forward indefinitely, but they retain their character. When the shareholder finally disposes of the stock, all suspended loss and deduction items are lost; they cannot be used to reduce any gain on the stock. Additionally:

• Non-dividend distributions exceeding the stock basis is taxed as capital gain, which is treated as long-term if held longer than 1 year.
• Non-deductible expenses reduce basis, but cannot be carried forward.
• Because items carried forward retain their character, any loss and deduction items that exceed basis must be allocated pro rata to those particular items.
• Current year loss and deduction items are combined with suspended losses and deductions, but are listed separately on Schedule E, Supplemental Income and Loss.

Problems on Retained Earnings

Some of the problems regarding retained earnings include the following:

• Shareholders are taxed on a percentage of the profits whether or not they end up receiving the money thereafter.
• If the S Corp has a silent partner investor, this individual might not be happy with paying taxes on profits that she may not actually receive, particularly if she doesn’t have authority in how the earnings will be handled after taxes are paid.

Liquidation in finance and economics is the process of bringing a business to an end and distributing its assets to claimants. It is an event that usually occurs when a company is insolvent, meaning it cannot pay its obligations when they are due. As company operations end, the remaining assets are used to pay creditors and shareholders, based on the priority of their claims. General partners are subject to liquidation.

All sales under the Bankruptcy Code, including sales of substantially all of a debtor’s assets, require bankruptcy court approval under Section 363 of the Bankruptcy Code. Typically, the debtor must show that it has obtained the highest and best bid for its assets through an auction process. In most cases, the debtor will obtain approval in advance of bid procedures, often with a stalking horse bidder already selected. When a stalking horse is used, the bid procedures approved by the court in advance will typically include a break-up fee and expense reimbursement if a higher and better bid is obtained in the sale process.

The bankruptcy court’s principal role is to adjudicate and preside over liquidations in order to ensure that a full and fair auction has been conducted and that the buyer satisfies the requirements of the Bankruptcy Court.

If a Chapter 7 case is commenced by the filing of a bankruptcy petition, or if the case is converted from a Chapter 11 case where no Chapter 7 trustee has been appointed, then an interim Chapter 7 trustee is appointed by the US trustee from a pre-selected panel of private trustees. A permanent Chapter 7 trustee may be elected at a creditors’ meeting held pursuant to the Bankruptcy Code, where creditors holding at least 20% of the allowable, undisputed, fixed, liquidated, unsecured claims may request and vote in an election (however, insider claimants and creditors with interests that are materially adverse to the other unsecured creditors may not request an election or vote). If no permanent Chapter 7 trustee is elected, then the interim Chapter 7 trustee becomes the permanent Chapter 7 trustee.

A Chapter 7 trustee’s primary obligation is to protect creditors’ interests. The Chapter 7 trustee must:

• Locate and collect all property of the debtor’s estate;
• Convert the property to cash by selling it following notice to parties in interest and a hearing by the bankruptcy court;
• Make distributions to the creditors in the order specified by the Bankruptcy Code; and
• Liquidate the estate as expeditiously as possible.

Additionally, to guarantee that its fiduciary obligations are met, among other things, a Chapter 7 trustee:

• Investigates the debtor’s financial affairs;
• Examines proofs of claim and objects to improperly allowed claims;
• Objects to the debtor’s discharge where appropriate;
• Provides information requested by parties in interest unless the court orders otherwise;
• Files periodic reports and summaries of the operation of the business, including statements of receipts and disbursements; and
• Provides a final report and files a final account of the administration of the estate with the us trustee and the court.

Distribution of Assets During Liquidation

Assets are distributed based on the priority of various parties’ claims, with a trustee appointed by the U.S. Department of Justice overseeing the process. The most senior claims belong to secured creditors who have collateral on loans to the business. These lenders will seize the collateral and sell it often at a significant discount, due to the short time frames involved. If that does not cover the debt, they will recoup the balance from the company’s remaining liquid assets, if any.

Next in line are unsecured creditors. These include bondholders, the government (if it is owed taxes) and employees (if they are owed unpaid wages or other obligations).

Finally, shareholders receive any remaining assets, in the unlikely event that there are any. In such cases, investors in preferred stock have priority over holders of common stock. Liquidation can also refer to the process of selling off inventory, usually at steep discounts. It is not necessary to file for bankruptcy to liquidate inventory.

Corporate Reorganizations

The corporate reorganization definition is something you should know if you are planning to change the tax structure of your corporation, facing bankruptcy, or preparing for a merger or acquisition. Reorganizing your corporation can be beneficial in a number of ways, from increasing profits to gaining protection in tough times. There are several different types of corporate reorganization, with varying purposes, benefits, and challenges.

Corporate reorganization may refer to any of the following:

• A process that has an impact on a corporation’s tax structure.
• The rehabilitation of the finances of a company following a bankruptcy.
• An acquisition, merger, or sale of a company that results in a change in ownership, stock, or management or legal structure.

Types

Type A: Mergers and Consolidations

Tax Almanac reported that the first recognized type of reorganization is a statutory acquisition or merger, wherein consolidations or mergers are both based on the acquisition of the assets of a company by another company.

Type B: Acquisitions: Target Corporation Subsidiaries

A Type B reorganization occurs when a corporation acquires the stock of another company, resulting in the acquired company becoming its subsidiary. It must be executed in a short timeframe, such as 12 months. Also, the acquisition must be the only one among measures that make up a larger plan for acquiring control. This type of reorganization must be performed for the sole purpose of acquiring voting stock.

Type C: Acquisitions: Target Corporation Liquidations

Unless the requirement is waived by the IRS, a targeted corporation is required to liquidate in order to be part of a Type C acquisition plan. Additionally, shareholders of the corporation will become shareholders of the acquiring company.

Type D: Transfers

A Type D transfer is categorized as either an acquisitive D reorganization or divisive D restructuring, which can be a spinoff or split-off. For instance, if Corporation A possesses former Corporation B’s assets and its own assets, Corporation B will go out of business, and the shareholders of former Corporation B will control Corporation A.

Type E: Recapitalizations

In a recapitalization transaction, a corporation’s shareholders exchange shares and securities for new shares, securities, or both. This move involves only one company and reconfigures the company’s capital structure.

Type F: Identity Changes

According to the Internal Revenue Code, a Type F reorganization refers to a change in identity, form, or location of an organization in a corporation. Generally, rules for this type of reorganization apply to a corporation that adopts a new name, changes the state in which it conducts business, or revises its corporate charter.

Type G: Transfers

A Type G reorganization involves bankruptcy by allowing the transfer of a failing company’s assets to a new corporation. The controlled corporation’s stock and securities will be distributed to the former company’s shareholders under the rules for distribution that apply to Type D transfers.

A dividend is the distribution of some of a company’s earnings to a class of its shareholders as determined by the company’s board of directors. Common shareholders of dividend-paying companies are typically eligible as long as they own the stock before the ex-dividend date. Dividends may be paid out as cash or in the form of additional stock.

When a corporation earns income, it has 2 choices as to what to do with it: it can retain the earnings so that it can invest in its business or it can distribute it as dividends to shareholders. Any distribution of cash or property to the owners of a corporation is known as a distribution. Whether that distribution is taxable depends on whether the distribution is classified as a dividend or a return of capital. A return of paid-in capital is not taxable, since it is not a profit. However, dividends are subject to double taxation, in that the corporation must pay a tax on its profits and the shareholders must pay a tax on the dividends received. A dividend is defined by IRC §316(a) as any distribution of cash or property by a corporation to its owners, but only to the extent that it was paid out of earnings and profit.

Unlike a sole proprietor, who can take money out whenever he or she wants to, a stockholder in a corporation has to wait for the board of directors to declare and pay a dividend. In a closely held corporation, where the owner may be the chair of the board and have all decision-making ability, declaring a dividend in order to take profits out of the company can be a simple process (remembering that the corporation paid income tax on the net earnings, and the shareholder will pay income tax on the dividend). However, in a publicly-traded company, or even a non-publicly traded company with many shareholders, declaring a dividend may be much more difficult, as it takes an action of the board of directors.

The tax code defines earnings and profits (E&P) as a company’s ability to pay out profits without returning paid-in capital. Current E&P is approximately equal to the corporate taxable income minus the federal income tax assessed on it, which is then subjected to the statutory adjustments listed in IRC §312. These statutory adjustments include deductions that reduce taxable income but do not reduce the corporation’s ability to pay dividends or vice versa. For example, the dividends-received deduction is deductible for income tax purposes but not for the computation of E&P, since it does not reduce the amount of money available to pay dividends. On the other hand, expenses and losses that cannot be deducted from taxable income can be deducted from E&P, such as the nondeductible expenses related to the production of tax-exempt income, since these deductions do reduce the ability to pay dividends even though they are not deductible for income tax purposes. In cases without these statutory adjustments, E&P can be approximated as the profits remaining after the payment of tax.

If a corporation has profits, then they can pay dividends with those profits, and any amount not paid out as dividends is retained by the corporation. Any amounts retained by the corporation increases accumulated E&P, which is the earnings and profits retained by the corporation from previous tax years. Accumulated E&P is a tax term for what, under financial accounting, is called retained earnings. Though similar, they may differ because of the statutory adjustments.

A corporation can pay a dividend either out of current E&P or accumulated E&P. If the amount of the dividend paid out exceeds the sum of both current E&P and accumulated E&P, then the percentage of the payment that will be considered a dividend will be the amount paid multiplied by the total E&P divided by the total dividend paid out. The remaining percentage of the dividend will be considered a nontaxable return of capital. However, if the corporation does not earn a profit for the current year, dividends can still be paid out of the accumulated E&P, even if a corporation has a current deficit.

If the amount paid out as dividends exceeds both E&P and accumulated E&P, then the excess is treated as a return of capital, which is not taxable to the shareholders. Any return of capital does not affect accumulated E&P. Although the stockholder is not taxed on the return of capital, the tax basis in the stock is reduced by the amount of the capital. If a return of capital exceeds the stockholders basis in the stock, then the excess must be treated as a capital gain.

% of Dividend Paid Out of E&P = Total Distribution  × Total E&P / Total Distribution

A corporate tax is a tax on the profits of a corporation. The taxes are paid on a company’s taxable income, which includes revenue minus cost of goods sold (COGS), general and administrative (G&A) expenses, selling and marketing, research and development, depreciation, and other operating costs.

Corporate tax rates vary widely by country, with some countries considered to be tax havens due to their low rates. Corporate taxes can be lowered by various deductions, government subsidies, and tax loopholes, and so the effective corporate tax rate, the rate a corporation actually pays, is usually lower than the statutory rate; the stated rate before any deductions.

C corps are subject to double taxation, which means the company will pay taxes on its profits and if some or all of those profits are distributed as a dividend to the shareholders, the shareholders will pay taxes on those dividend payments.

The company pays corporate income taxes on its taxable profit, which is what’s left after subtracting the business’s costs and expenses from its revenue. The federal corporate tax rate is currently a flat 21 percent.

Shareholders pay capital gains tax  on dividends distributed to them throughout the year per the discretion of the board of directors.

At tax time, C corps complete the following two forms:

• IRS Form 1120: U.S. Corporation Income Tax Return is used to report the C corp’s gross income, tax deductions, and taxable profit.
• Form 1099-DIV is provided to each shareholder, reporting the amount of profit that was distributed to them.

There are two types of dividends: qualified and nonqualified.

Nonqualified dividends are dividend payments that don’t meet the qualified dividends requirements and don’t receive special tax treatment. There are some types of dividend payments that are automatically nonqualified including:

• Capital gains distributions
• Dividends on bank deposits
• Dividends from an Employee Stock Ownership Plan
• Dividends paid from a tax-exempt organization, master limited partnership, or real estate investment trusts

Qualified dividends have a lower tax rate but need to meet several requirements.

First, they must be paid out to shareholders from a US corporation or qualifying foreign corporation.

Second, a shareholder must hold the stock for at least 60 days out of a 121-day “holding period,” which begins 60 days before the “ex-dividend date.” If you’re a shareholder, you’ll need to own the stock by this date to receive a dividend payment.

Luckily, shareholders don’t need to worry about figuring out if a dividend is qualified or nonqualified. Form 1099-DIV will list the amount and type of dividend payment.

LLC vs. C corp: Tax the owner pays

Corporate Income Tax Rate: 8.7% of federal taxable income allocated and apportioned to Delaware based on an equally weighted three-factor method of apportionment. The factors are property, wages and sales in Delaware as a ratio of property, wages and sales everywhere.

Consolidated Corporate Income Tax Returns: Not Permitted. Each member of a consolidated group must file a separate return, reporting income and deductions as if a separate Federal Income Tax Return was filed.

Estimated Tax Liability: To be prepaid by every corporation in four installments: 50% (due on or before the first day of the fourth month of the taxable year) 20% (due on or before the 15th day of the sixth month of the taxable year) 20% (due on or before the 15th day of the ninth month of the taxable year) 10% (due on or before the 15th day of the 12th month of the taxable year).

Penalties:  a.  A penalty of 1½% per month is imposed on the failure to pay, timely pay or underpay any estimated tax installments. b. Late Returns are subject to a penalty of 5% per month, up to a maximum of 50% of the tax due plus interest of 1% per month from the original due date until the tax is paid. In addition, an additional penalty of 1/2% per month, not to exceed 25%, is imposed for failure to pay (in whole or in part) the tax liability due on a timely filed return.

Steps:

Decide Whether to Be Taxed as an S Corp. or a C Corp.

When you form a corporation, your business is automatically treated as a C corporation for federal income tax purposes.

A C corporation is a traditional corporation that pays corporate income tax on its profits, with its shareholders paying tax on the salary and dividends they receive.

This taxation of dividends at both the corporate and individual levels is sometimes referred to as “double taxation.”

File an S Corporation Election

If you want your business to be taxed as an S corporation, you must fill out Internal Revenue Service Form 2553, have all shareholders sign it, and file it with the IRS.

The deadline for filing the form is 2 months and 15 days after the beginning of the tax year. If you are a newly formed corporation, your tax year begins when your corporation is formed.

The IRS instructions for Form 2553 include a full explanation of these deadlines. The IRS must approve your S corporation election. Once you’ve elected S corporation status and it’s been approved, the election stays in effect until it is terminated or revoked.

Learn About Tax Deductions for Corporations

In addition to the ordinary business expenses that all small businesses can deduct, corporations can deduct employee salaries and bonuses and the cost of employee health insurance and retirement plans.

Understanding these deductions will help you make choices that will maximize your tax savings.

Pay Estimated Taxes

C corporations must pay estimated corporate income tax, and S corporations must make estimated tax payments for certain S corporation taxes. Estimated tax payments must be made quarterly throughout the year.

Corporations that do not pay their estimated tax payments on time can be subject to interest and penalties for underpayment.

File Your Federal Tax Return

The type of tax return you file for your corporation will depend on whether you’re an S corporation or a C corporation.

If your business is an S corporation, you’ll file Form 1120S, a tax return that shows your corporation’s income, expenses, and losses.

You’ll also file a Form K-1 for each of your corporation’s shareholders, showing their share of the corporation’s income, deductions and credits. You must provide your shareholders with copies of their K-1 forms so they can report their share of the corporate income or loss on their personal income tax returns.

File Your State Tax Returns

Depending on your tax status and the state where your corporation was formed, you may also have to file a state income tax return for your corporation.

The corporate tax rate is usually a flat percentage that varies from state to state. If you are registered to do business in additional states, those states may also require state tax returns for your corporation and/or its shareholders.

Corporate taxes can be confusing, so it pays to get advice from a tax professional before choosing your corporation’s tax status or preparing your taxes.

An accountant can explain the consequences of C corporation or S corporation taxation, advise you on maximizing your business tax deductions, and prepare your return.

A C Corporation is one of several ways to legally recognize a business for tax, regulatory and official reasons. A C Corp is simply a way to structure ownership of a business, and contrasts with other popular business structures including Limited Liability Companies (LLCs), S Corporations, Sole Proprietorships and others. It’s is a legal structure for a corporation in which the owners, or shareholders, are taxed separately from the entity. C corporations, the most prevalent of corporations, are also subject to corporate income taxation. The taxing of profits from the business is at both corporate and personal levels, creating a double taxation situation.

C-corps can be compared with S corporations and limited liability companies (LLCs), among others, which also separate a company’s assets from its owners, but with different legal structures and tax treatment.  A newer type of organization is the B-corporation (or benefit corporation), which is a for-profit firm but different from C-corps in purpose, accountability, and transparency, but aren’t different in how they’re taxed.

Organizing a C Corporation

The first step in forming a C corporation is to choose and register an unregistered business name. The registrant will file the articles of incorporation with the Secretary of State according to the laws of that state. C corporations offer stock to shareholders, who, upon purchase, become owners of the corporation. The issuance of stock certificates is upon the creation of the business.

All C corporations must file Form SS-4 to obtain an employer identification number (EIN). Although requirements vary across jurisdictions, C corporations are required to submit state, income, payroll, unemployment, and disability taxes. In addition to registration and tax requirements, corporations must establish a board of directors to oversee management and the operation of the entire corporation. Appointing a board of directors seeks to resolve the principal-agent dilemma, in which moral hazard and conflicts of interest arise when an agent works on behalf of a principal.

Creating a C Corporation is more complicated than forming a limited liability company or a sole proprietorship, but there are several tax benefits your company could enjoy.

It is a brief guide for creating a C Corporation, which also is called a regular corporation. Please consult financial and tax advisers for more detailed information.

A C Corporation:

• Is not a personal tax liability for its owners
• Has a more complex structure than a limited liability company
• Is legally independent of its owners
• Has a board of directors and shareholders

Benefits of a C Corporation

C corporations limit the personal liability of the directors, shareholders, employees, and officers. In this way, the legal obligations of the business cannot become a personal debt obligation of any individual associated with the company. The C corporation continues to exist as owners change and members of management are replaced.

A C corporation may have many owners and shareholders. However, it is required to register with the Securities and Exchange Commission (SEC) upon reaching specific thresholds. The ability to offer shares of stock allows the corporation to obtain large amounts of capital which may fund new projects and future expansions.

Setting up a C Corporation

A C Corporation is established with state authorities and must abide by corporate laws in the state where it is incorporated. Experts recommend that small-business owners establish corporations in their home states. Check which agency handles this in your state. The secretary of state’s office often registers corporations.

To form a C Corporation, you will need to register your business name, file a certificate of incorporation, or articles of incorporation, and pay a fee. You will also need to draft corporate bylaws and hold a board of director’s meeting.

1. Select and obtain a corporation name.

Your first step in establishing a C corporation is to select a company name. This may not be as easy as it sounds.

First, your company name should end in “Corporation,” “Incorporated,” “Limited,” or an abbreviation of one of those words.

2. Appoint officers to the corporation.

At a minimum, you need a director for your corporation. If you are a small business owner, you may choose to make yourself the only director. This is also the time to select and identify any officers in the business. Again, if you are a solo business owner, you can designate yourself the only officer of the corporation.

3. File articles of incorporation with the state.

In addition to reserving a company name, you need to file articles of incorporation with the state. Some states refer to articles of incorporation as a certificate of incorporation. Other states use the word “charter.” Contact the Secretary of State or other comparable authority to determine the title of the forms your state of incorporation requires. You can get copies of the forms from the Secretary of State’s office. Business owners may choose to fill out the forms themselves. However, because they must be legally correct in order to be valid, many people choose to hire an attorney for this step.

4. Write company bylaws.

In order to have a corporation, there must be bylaws that detail the rules and guidelines for operating the business. At a minimum, bylaws should indicate who can vote and when to hold directors’ meetings. Some smaller businesses make the mistake of skipping this step. The owner might think that because they are the only officer and director, there is no need to waste time writing down the fact that they are the only one who can vote or decide when to meet with themselves about the company’s business. However, skipping this step can be fatal to the establishment of a C corporation. The company bylaws must be written, no matter how silly it might seem.

5. Issue stock.

Often, new business owners select a C corp. because of the benefits of issuing stock. However, this cannot be in name only. A business owner must actually issue shares of stock. Blank share certificates are available for purchase at office supplies stores or online. These shares indicate the percentage of the corporation each stockholder owns. In a single-person business, the owner would own 100 percent of the shares of business stock.

6. Hold directors’ meetings as detailed in the bylaws.

Bylaws are not simply a document to write and then ignore. Directors’ meetings must take place according to the schedule listed in the bylaws. The first meeting must include the approval of the bylaws. Minutes of every meeting must be kept in writing. The corporation must preserve these minutes and make them available upon request. Regular meetings of the directors must continue on the schedule detailed in the bylaws, or the company risks losing C corp. status.

Fiduciary Accounting

Beneficiaries under a will or trust have a right to be kept informed at all times about the management of the estate or trust and the fiduciary has a duty to so inform them. Managing and maintaining records for an estate or trust requires understanding the principles of fiduciary accounting. Receipts and expenditures are classified as either income or principal. For example, dividends, interest and rents (income) must be accounted for separately from the trusts assets (principal). This characteristic distinguishes fiduciary accounting from any other type of account recordkeeping. The allocation between income and principal is significant for estates but has greater importance in trust administration. A trust has two classes of beneficiaries the current beneficiaries and the remaindermen. The current beneficiaries have a beneficial interest in income or principal, or both, during the life of the trust. The remaindermen inherit the trust principal when the trust terminates. The classification of receipts and expenditures between income and principal has a direct impact on what each class of beneficiary receives.

The fiduciary of a domestic decedent’s estate, trust, or bankruptcy estate files Form 1041 to report:

• The income, deductions, gains, losses, etc. of the estate or trust.
• The income that is either accumulated or held for future distribution or distributed currently to the beneficiaries.
• Any income tax liability of the estate or trust.
• Employment taxes on wages paid to household employees.

Form 1041 (fiduciary tax return) is the income tax form used for estates and trusts. It is used to report INCOME in the estate or trust, including sales of property. The estate or trust exists until final distribution of its assets.

The tax year for an estate can be a calendar year or a fiscal year; the type of year is chosen when the first Form 1041 is filed for the estate. Once chosen, the tax year can only be changed with IRS permission. A calendar year is required for trust returns.

INCOME Filing Requirement: A return must be filed if the estate or trust has gross income of $600 or more. However, if one or more beneficiaries are a non-resident alien, Form 1041 must be filed even if the gross income is less than $600, regardless of taxable income.

A form K-1 is filed with the Form 1041 for each beneficiary. A copy of the K-1 must be furnished to each beneficiary. The K-1 shows the allocation of the beneficiary’s share of the estate-trust income and losses that the beneficiary will need to report on his or her individual income tax return.

Tax on the VALUE OF ASSETS in the Estate: A Form 706 is required if the gross estate is greater than the taxpayer’s estate tax exemption. Unless reduced because of pre-death gifts, the federal estate tax exemption for 2018 is $11,200,000 for individuals and $22,400,000 for married couples, up significantly from 2017 rates of $5,490,000 and $10,980,000 respectively. The exemption amounts are scheduled to increase for inflation until 2025. On January 1, 2026 they revert back to the 2017 exemption amounts. The highest marginal estate and gift tax rate remains at 40% of the net value of the estate.

Preparing and Filing Tax Returns

Executors and trustees are responsible for filing a variety of tax returns for the estates and trusts they manage. If accountants practice in this area of taxation, they can provide this service; if they dont, they can advise clients on what is required and refer them to a specialist. Obviously, CPAs need to understand the basic requirements and tax planning issues before advising a client.

Decedents final income tax returns. Under Internal Revenue Code section 6012(b)(1), the executor or trustee is responsible for filing any tax returns the decedent would have been required to file if still living, including the decedents final income tax returns, and for paying any taxes due. However, section 6013(a) says the surviving spouse shares this responsibility if a joint return is filed. Filing a joint return with the surviving spouse is an election the fiduciary must make after considering income splitting to possibly lower the tax bracket, using the decedents deductions, avoiding joint and several liability, increasing the availability of medical deductions and casualty losses. Tax planning considerations are important here, and the individual fiduciary needs competent advice.

Fiduciary income tax returns. An executor or trustee is responsible under IRC section 6012(b)(4) for filing a fiduciary income tax return and paying any taxes due for each year an estate or trust exists. In general, the beneficiaries are taxed on the income paid out or required to be distributed under the terms of a trust. Retained income is taxed to the estate or trust. Estate or trust income that exceeds $7,900 is taxed at the maximum federal rate of 39.6%. Since any estate income not needed to pay estate expenses will be distributed to the beneficiaries when estate administration is completed, the executor or trustee must consider whether to distribute income to the beneficiaries before the estate is closed.

Federal estate tax return. The executor of an estate generally is responsible for filing the estate tax return (Form 706, United States Estate Tax Return ), if one is required. If the value of the gross estate exceeds $600,000, the executor must file a federal estate tax return no later than nine months from the date of death, with a possible six-month filing extension under IRC section 6018(a). If the court has not appointed an executor because there is no probate estate, IRC section 2203 says the executor for purposes of filing the return is “any person in actual or constructive possession of any property of the decedent.” The trustee of the decedents trust is required to file the return under this circumstance. The executor or the trustee is personally liable for filing the estate tax return and paying any tax due. To protect himself or herself, the executor or trustee should make a request for early determination of the tax and discharge from personal liability under IRC section 2204. This request should be made at the time the return is filed.

The U.S. generation-skipping transfer tax (a/k/a “GST tax”) imposes a tax on both outright gifts and transfers in trust to or for the benefit of unrelated persons who are more than 37.5 years younger than the donor or to related persons more than one generation younger than the donor, such as grandchildren. These people are known as “skip persons.” In most cases where a trust is involved, the GST tax will be imposed only if the transfer avoids incurring a gift or estate tax at each generation level.

The GSTT is a simplified version of a tax originally instituted in 1976. Back then, Congress explained that the tax was designed “to remedy the perceived abuse of using a trust to benefit several generations while avoiding Federal Estate Tax during the term of the trust.”

Assume, for example, a donor transfers property in a trust for the donor’s child and grandchildren and that during the child’s lifetime, the trustee may distribute income among the child and grandchildren in accordance with their needs. Assume further that the trust instrument provides that the remaining principal of the trust will be distributed outright to the grandchildren following the child’s death. If the trust property is not subject to estate tax at the child’s death (by reason of a general power of appointment, e.g.), a GST tax will be imposed when the child dies. This is called a “taxable termination.” In that case, the trustee is responsible for filing a GST tax return and paying the tax. On the other hand, a “taxable distribution” occurs if the trustee distributes income or principal to a grandchild before the trust terminates. In that case, the beneficiary is responsible for paying the tax. These taxable events are sometimes overlooked by people who may be unaware of the existence of the tax or its application to their situation. See IRS Forms 706 GS (D-1)) and 706 GS(T).

Strategies for Exemption Allocation

The GSTT comes into play whenever a donor gifts assets to what the tax law calls a “skip person.” Such a transfer skips one or more younger generations to a person related to the transferor by blood, marriage or adoption. Grandchildren and great-grandchildren are the most common skip persons. But under the deceased parent rule (IRC § 2651(e)), descendants are moved up to their parent’s level if the parent dies before the date of transfer. Thus, a grandchild who might be a skip person to his or her grandparent will not be treated as a skip person if his or her parent dies before the grandparent. An unrelated person is a skip person if he or she is more than 37½ years younger than the transferor.

A trust is a skip person in two circumstances:

(a) All of the beneficial interests of the trust are held by skip persons.

(b) No current beneficial interests are held by skip persons, but no distributions can be made to “non–skip persons” (the term for anyone who isn’t a skip person). A person has a beneficial interest in a trust in two circumstances:

(a) He or she has a present right to income or principal.

(b) He or she is a permissible income or principal recipient (for example, there are no current mandatory income or principal beneficiaries, and the trustee has the right to sprinkle income or principal to a group that includes the person in question).

The gift tax is a federal tax applied to an individual giving anything of value to another person. For something to be considered a gift, the receiving party cannot pay the giver full value for the gift, though they may pay an amount less than its full value.

The gift donor must report the gift on their tax return and pay the gift tax. Normally, the recipient doesn’t have to report the gift. Under special circumstances, the recipient may pay the gift tax.

The federal gift tax was created to prevent taxpayers from giving money and items of value to others to avoid paying income taxes. The gift tax is applied to the donor to prevent undue hardship and to oblige givers to honor their tax liability, as the Internal Revenue Service (IRS) dubs the giver.

The gift tax can be hefty: Rates range from 18% to 40% on a sliding scale, based on how big the taxable gift is. However, there are a lot of exceptions to the gift tax.

The following are generally not subject to gift tax:

• Gifts to a political organization for its use.
• Gifts to the donor’s spouse. An unlimited amount can be gifted tax-free if the spouse is a U.S. citizen. If the spouse is not a U.S. citizen, then tax-free gifts are limited to an annually adjusted value ($159,000 in 2021).
• Medical and educational expenses payments made by a donor to a person or an organization, such as a college, doctor, or hospital.
• Gifts to a charitable organization.
• Gifts that are valued at less than the annual gift tax exclusion rate for that year.

Gift Tax Strategies

There are strategies for avoiding or minimizing the gift tax.

Gift in Trust

Donors can give gifts in excess of the annual exclusion without paying taxes by establishing a special type of trust the Crummey trust is the usual arrangement to receive and distribute the funds.

The gift tax exclusion usually doesn’t apply to money distributed by trusts. But a Crummey trust allows the beneficiary to withdraw the assets within a limited time period say, 90 days or six months. This gives the beneficiary what the IRS calls a “present interest” in the trust and this sort of distribution can qualify as a nontaxable gift. Of course, the recipient can only take out a sum equal to the gift given to the trust.

Gift Splitting

Being married allows you to double your gifts. Remember, the annual exclusion applies to the amount of gift that an individual can give a recipient. That means that even if they file a joint tax return, spouses can each give $15,000 to the same recipient effectively raising that gift to $30,000 per year without triggering the gift tax.

This strategy is known as “gift splitting” and enables wealthy couples to give substantial annual gifts to children, grandchildren, and others. This gift can be on top of, say, tuition paid directly to a grandchild’s school or college which is exempted outright from the gift tax.

Gift Tax Return

The federal gift tax return is known as Form 709. It must be filed under certain conditions by the donor of a gift. Gift recipients normally don’t have to report gifts though they may pay the gift tax, or a percentage of it, on the giver’s behalf (in which case they would have to file the form).

Individuals who give a gift that exceeds the annual or lifetime exempt gift limit established by the IRS must fill out and submit Form 709.6 This form is due on the same date as the individual’s tax return (Form 1040), which is typically April 15 of the year after the gift was made.

Form 709 includes calculations for how much gift tax, if any, is owed. But filing Form 709 doesn’t necessarily mean that you pay the gift tax. If you’ve given a gift that exceeds the annual exclusion maximum ($15,000 in 2021) but is still under the lifetime maximum ($11,700,000 in 2021), then you won’t trigger the gift tax. But you still must report the gift.

How To Complete Form 709

• Determine whether you are required to file Form 709.
• Determine what gifts you must report.
• Decide whether you and your spouse, if any, will elect to split gifts for the year.
• Complete lines 1 through 19 of Part 1—General Information.
• List each gift on Part 1, 2, or 3 of Schedule A, as appropriate.
• Complete Schedules B, C, and D, as applicable.
• If the gift was listed on Part 2 or 3 of Schedule A, complete the necessary portions of Schedule D.
• Complete Schedule A, Part 4.
• Complete Part 2—Tax Computation.
• Sign and date the return.

Who Must File

In general. If you are a citizen or resident of the United States, you must file a gift tax return (whether or not any tax is ultimately due) in the following situations.

• If you gave gifts to someone in 2020 totaling more than $15,000 (other than to your spouse), you probably must file Form 709. But see Transfers Not Subject to the Gift Tax and Gifts to Your Spouse, later, for more information on specific gifts that are not taxable.
• Certain gifts, called future interests, are not subject to the $15,000 annual exclusion and you must file Form 709 even if the gift was under $15,000. See Annual Exclusion, later.
• Spouses may not file a joint gift tax return. Each individual is responsible for his or her own Form 709.
• You must file a gift tax return to split gifts with your spouse (regardless of their amount) as described in Part 1—General Information, later.
• If a gift is of community property, it is considered made one-half by each spouse. For example, a gift of $100,000 of community property is considered a gift of $50,000 made by each spouse, and each spouse must file a gift tax return.
• Likewise, each spouse must file a gift tax return if they have made a gift of property held by them as joint tenants or tenants by the entirety.
• Only individuals are required to file gift tax returns. If a trust, estate, partnership, or corporation makes a gift, the individual beneficiaries, partners, or stockholders are considered donors and may be liable for the gift and GST taxes.
• The donor is responsible for paying the gift tax. However, if the donor does not pay the tax, the person receiving the gift may have to pay the tax.
• If a donor dies before filing a return, the donor’s executor must file the return.

Who does not need to file.

If you meet all of the following requirements, you are not required to file Form 709.

• You made no gifts during the year to your spouse.
• You did not give more than $15,000 to any one donee.
• All the gifts you made were of present interests.