Tax Planning

Tax planning is an important part of any financial transaction. Whether you are entering into a business or a personal investment, tax consequences should be considered as part of the decision making process.

The type of entity you choose for your business can have significant tax consequences. A sole proprietorship, which is the term for an unincorporated business operated by a single owner, will be taxed directly to the owner. If two or more owners go into business without forming a legal entity such as a corporation or limited liability company to conduct the business, a partnership is formed. In a partnership, the owners are taxed on their share of the business' profits and losses. These profits and losses can be allocated in almost any way by agreement of the partners, so long as the allocation has "substantial economic effect." Artificial allocations will not be respected by the IRS: the allocations need to "follow the money" to have substantial economic effect.

A corporation can be taxed as a separate entity (commonly referred to as a regular or "C" corporation), or the owners can elect to be taxed as an S corporation. A C corporation will be taxed separately on its earnings, and the shareholders will be taxed again on any distributions they receive from the corporation. This "double taxation" is one of the main disadvantages of operating as a C corporation. However, depending on the amount of income the corporation and the shareholders earn, operating as a C corporation can actually lower the parties' overall tax bill. C corporations are allowed to provide employee benefits to their owner-employees at levels beyond other entities, and these benefits can generally be deducted for tax purposes. Of course there are other non-tax benefits that may make a C corporation the right choice for you.

Certain small business corporations can elect S corporation status. An S corporation pays no tax: its profits and losses are taxed directly to the shareholders, whether or not they are distributed to them. However, there are limits to the number and type of shareholders in an S corporation. In addition, an S corporation can have only one class of stock (although non-voting stock is not generally considered a second class of stock). These limitations limit the flexibility of S corporations, and may make them unsuitable for certain activities.

A limited liability company, or LLC, can elect to be taxed in a number of ways by filing a form with the IRS. An LLC can elect to be taxed as a C corporation or an S corporation, depending on the results the owners desire. If no election is made, a single-member LLC will be taxed as a sole proprietorship, while one with multiple members will be taxed as a partnership.

A business trust is a flexible entity which has tax characteristics similar to an LLC. A Virginia business trust can elect its tax treatment, and may be taxed as a sole proprietorship (single-owner), partnership, C corporation or S corporation.

Certain types of investments may create higher taxes if placed in a particular type of entity. For example, if your business has foreign owners, it cannot elect S corporation status. Real estate investments may create tax problems if owned by a corporation. Likewise, there can be significant tax and nontax advantages in using multiple entities when you set up your business. These are just some examples of why tax planning at the start of your enterprise can pay big dividends in the future.

Saving taxes on your business transaction can reduce the cost and increase the cash available to you. Sales of investment or business real estate can often be accomplished without a current tax liability through a Section 1031 like-kind exchange. The proper allocation of the purchase price in a purchase/sale of a business can reduce taxes for both the buyer and the seller. It is also possible to use money from your company retirement plan to finance your business without a current tax liability. Finally, your family's estate plan should be structured to minimize the effect of estate taxes, which reduce the value passed on to your heirs.

For all of these reasons, it is important that your business advisory team include attorneys and advisors who are experienced in tax matters.