@212 CHAP 2

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        ³SELECTION OF LEGAL ENTITY -- OVERVIEW OF CHOICES³
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@Q      "The hardest thing in the world to understand is
@Q       Income Tax." -- Albert Einstein

@IF901xx]Your business has not yet started up.  Thus you still have an
@IF901xx]opportunity to select the most favorable type of legal entity
@IF901xx]for @NAME when it comes into being.
@IF901xx]
@IF901xx]The following outline and summary will give you a fairly de-
@IF901xx]tailed overview of which type of entity is likely to be best
@IF901xx]for your particular business, which you have indicated is in
@IF901xx]the field of @BUSTYPE.
@IF901xx]
@IF900xx]Your firm, @NAME, has already selected
@IF900xx]a form of doing business, which is a @ENTITY.
@IF900xx]
@IF900xx]However, it is possible that your choice of legal entity is
@IF900xx]not the optimum alternative for your particular business and
@IF900xx]personal needs.  The following outline and summary will give
@IF900xx]you some basic guidance as to whether you should explore the
@IF900xx]possibility of switching to some other legal form of business
@IF900xx]organization at this point in the game.
@IF900xx]
Choosing the "best" legal form or entity for your business
is rarely an easy decision to make.  Each form of business,
sole proprietorship, partnership, and corporation, has its
own benefits and shortcomings, which vary in degree depend-
ing on the kind and size of your business, your tax situa-
tion, profitability, personal predilections, and numerous
other factors, some of which may seem important to you,
others of which may not.  Thus there is often no "right"
answer as to which legal entity you should select for oper-
ating your business.

The following is a thumbnail sketch or overview of some of
the major advantages and disadvantages of sole proprietor-
ships, partnerships, and corporations.  Where there are
differences between a general partnership and a limited
partnership, or between a regular ("C") corporation and an
S corporation, separate comments are shown for each.  Other-
wise, the comments regarding partnerships apply to both
general and limited partnerships, and the comments regard-
ing corporations relate to both regular and S corporations.
@CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MI MN MT NB NV ND OK RI SD TX UT VA WV WY
Because your state, along with 27 others, has adopted a new
kind of legal entity, called a "limited liability company,"
which is much like a partnership, but with limited liability
for all its owners, the following discussion also includes
consideration of such "LLCs" in the state of @STATE.
@CODE:OF

As a general rule, it seems that some types of businesses
are much more likely than others to benefit from adopting a
certain legal form, as in the case of the following (press
<Enter> key for details on highlighted words):

      .äProfessional service firmsè(law, accounting, etc.);            \113

      .äCapital-intensive firmsèneeding to accumulate capital;         \114

      .äReal estate rentalèbusinesses, in general; and                 \115

      .äAuthors, inventorsèand software developers receiv-             \116
        ing royalty income for licensing intellectual
        property.



                  SIMPLICITY IN OPERATION AND FORMATION:

    .äProprietorshipè      Simplest to establish and operate.          \110

    .äGeneral Partnershipè Relatively simple, informal, but            \111
                           is usually desirable to have for-
                           mal written agreement between the
                           partners.

    .äLimited Partnershipè More complex and expensive than             \112
                           other unincorporated forms of
                           business to establish.  Requires
                           written agreement, filing of cer-
                           tificate.  Managed by general
                           partners only.

@CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MI MN MT NB NV ND OK RI SD TX UT VA WV WY
    .äLim. Liability Co.è  A new type of entity, which your            \406
                           lawyer may not yet be very famil-
                           iar with.  Requires written arti-
                           cles of organization, roughly
                           comparable to a corporation or a
                           limited partnership in terms of
                           complexity in formation.  Can be
                           formed under the state laws of
                           @STATE.
@CODE:OF
@CODE: IL

                           (Note, however:  The Illinois LLC
                           law does not go into effect until
                           January 1, 1994.)
@CODE:OF

    .äRegular Corporationè Requires most formality in estab-           \135\231
                           lishment and operation, generally.

    .äS Corporationè       Same as regular corporation, but            \234
                           requires close oversight by a
                           tax advisor, an additional cost.

                  LIABILITY FOR DEBTS, TAXES & OTHER CLAIMS:

    . Proprietorship       Owner has unlimited personal
                           liability.

    . General Partnership  Partners all have unlimited per-
                           sonal liability.

    . Limited Partnership  General partners are personally
                           liable; limited partners are li-
                           able only to the extent of their
                           investment, generally.

@CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MI MN MT NB NV ND OK RI SD TX UT VA WV WY
    . Lim. Liability Co.   "Members" (owners) not generally
                           liable for company's debts, under
                           the state laws of @STATE.
                           But may have to guarantee loans,
                           as a practical matter, if compa-
                           ny is to be able to borrow money.
                           Also, corporate officers may be
                           liable for failure to withhold
                           and pay over to IRS, withholding
                           taxes on employees' wages.

@CODE:OF
    . Corporation          Stockholders not generally li-
                           able for corporate debts, but
                           often have to guarantee loans,
                           as a practical matter, if cor-
                           poration is to borrow money.
                           Also, corporate officers may be
                           liable for failure to withhold
                           and pay over to IRS, withholding
                           taxes on employees' wages.

                  FEDERAL INCOME TAXATION OF
                  BUSINESS PROFITS:

    . Proprietorship       Taxed to owner at individual
                           tax rates of up to 31% or more
                           in 1992 and 1993.

    . Partnership          Taxed to partners at their indiv-
                           idual tax rates.
@CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MI MN MT NB NV ND OK RI SD TX UT VA WV WY

    . Lim. Liability Co.   Taxed to owners at their individ-
                           ual tax rates, if organized so
                           as to be taxed as a partnership
                           for federal income tax purposes.
@CODE:OF
@CODE: FL
                           (Note, however, that for Florida
                           state income tax purposes, an LLC
                           is taxed as a corporation.)
@CODE:OF

    . Regular Corporation  Taxed to corporation at rates
                           higher than those of individuals
                           (maximum of 34% or 39% in 1992
                           and 1993).

    . S Corporation        Taxed to individual owners at
                           their individual rates (but cer-
                           tain gains are taxable to the
                           corporation as well).

                  DOUBLE TAXATION IF PROFITS ARE WITHDRAWN
                  FROM THE BUSINESS:

    . Proprietorship       No.

    . Partnership          No.
@CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MI MN MT NB NV ND OK RI SD TX UT VA WV WY

    . Lim. Liability Co.   No, generally, if treated for tax
                           purposes as a partnership.
@CODE:OF

    . Regular Corporation  Yes. (But major exception exists
                           foräreasonable compensationè that           \105
                           is paid to owners who are employ-
                           ees of the corporation.)

    . S Corporation        No, in general.

                       DEDUCTION OF LOSSES BY OWNERS:

    . Proprietorship       Yes.

    . Partnership          Yes.  Limited partner's deduc-
                           tions generally cannot exceed
                           the amount he or she has invested
                           in a limited partnership interest
                           (except for real estate, in some
                           instances).
@CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MI MN MT NB NV ND OK RI SD TX UT VA WV WY

    . Lim. Liability Co.   Yes, generally, if treated as a
                           partnership for tax purposes. Tax
                           treatment is not totally resolved
                           yet, but may actually have some
                           advantages over limited partner-
                           ships for holding real estate.
@CODE:OF

    . Regular Corporation  No.  Corporation must carry over
                           any initial losses until able to
                           offset them against future prof-
                           its, if ever.

    . S Corporation        Yes, in general, for federal tax
                           purposes. Loss for a shareholder
                           is limited to investment in his
                           or her stock, plus amount loaned
                           to corporation.

               SOCIAL SECURITY TAXES ON EARNINGS OF
               OWNER FROM THE BUSINESS:

    . Proprietorship       15.3% of owner'säself-employmentè           \262
                           earnings in 1993, up to $57,600
                           of income, plus 2.9% of S/E in-
                           come over $57,600, to $135,000.
                           Half of the S/E tax is deductible
                           for income tax purposes.

    . Partnership          15.3% of each partner's share of
                           self-employment earnings from
                           the business in 1993, on up to
                           $57,600 of such earnings, plus
                           2.9% on excess over $57,600 (up
                           to maximum S/E income of
                           $135,000).
@CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MI MN MT NB NV ND OK RI SD TX UT VA WV WY

    . Lim. Liability Co.   Same as partnership, if LLC is
                           is organized in such as way as to
                           be recognized as a partnership
                           for tax purposes.
@CODE:OF

    . Corporation          Owner/employee of corporation
                           pays 7.65% on his or her salary
                           and corporation also pays 7.65%.
                           TotaläSocial Security (FICA) taxè           \258
                           is 15.3% of up to $57,600 of sal-
                           ary in 1993 (plus 2.9% on excess
                           over $57,600, up to maximum S/E
                           income of $135,000).

               UNEMPLOYMENT TAXES ON EARNINGS OF
               OWNER FROM THE BUSINESS:

    . Proprietorship       None.

    . Partnership          None.
@CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MI MN MT NB NV ND OK RI SD TX UT VA WV WY

    . Lim. Liability Co.   None, if treated as partnership.
@CODE:OF

    . Corporation          Yes. äUnemployment taxesè (state            \260
                           and federal) apply to salaries
                           paid to owners.

                         RETIREMENT PLANS:

    . Proprietorship       Keogh plan.  Deductions, other
                           features now generally the same
                           as for corporate pension and
                           profit sharing plans.  But a par-
                           ticipant who is owner cannot bor-
                           row from a Keogh plan.

    . Partnership          Keogh plan.  Same as for sole
                           proprietorship except that the
                           prohibition on borrowing from
                           plan applies to any 10% or
                           greater partner.
@CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MI MN MT NB NV ND OK RI SD TX UT VA WV WY

    . Lim. Liability Co.   Same as for partnership, if rec-
                           ognized as partnership for tax
                           purposes.
@CODE:OF

    . Regular Corporation  Corporate retirement plans no
                           longer are significantly better
                           than Keogh plans.  Deduction
                           limits same now as for Keogh.
                           But participants can borrow from
                           corporate plan, within limits.

    . S Corporation        Plans now essentially identical
                           to regular corporate retirement
                           plans, except that "shareholder-
                           employee" (owning 5% or more of
                           the stock) of S corporation can-
                           not borrow from retirement plan.

                 TAX TREATMENT OF MEDICAL, DISABILITY, AND
                 GROUP-TERM LIFE INSURANCE ON OWNERS:

    . Proprietorship       Not deductible, except that part
                           of medical expenses may be an
                           itemized deduction on owner's
                           tax return, including medical
                           insurance premiums.  But 25% of
                           medical insurance on owner is
                           now allowed as a deduction in
                           computing adjusted gross income.

    . Partnership          See proprietorship, above.
@CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MI MN MT NB NV ND OK RI SD TX UT VA WV WY

    . Lim. Liability Co.   Same as partnership, if treated
                           as partnership for tax purposes.
@CODE:OF

    . Regular Corporation  Corporation may be able to de-
                           duct theämedical insuranceèprem-            \241
                           ium or reimbursements paid under
                           a medical reimbursement plan.
                           Generally not taxable to the em-
                           ployee, even if employee is an
                           owner, if plan is not considered
                           discriminatory.  Similar treat-
                           ment is provided forädisabilityè            \240
                           coverage and up to $50,000 of
                           coverage (per employee) for
                          ägroup term life insuranceèplans.            \242

    . S Corporation        Fringe benefits for 2% sharehol-
                           ders may be deductible by corpor-
                           ation, but such expense will be
                           treated like additional (taxable)
                           compensation to shareholder-
                           employees who own more than 2%
                           of the stock of the company.
                           (But may not be subject to FICA
                           tax in the case of medical insur-
                           ance, if such coverage is provid-
                           ed to employees generally by the
                           S corporation.)

                       TAXATION OF DIVIDENDS RECEIVED
                       ON INVESTMENTS:

    . Proprietorship       Dividends received on stock in-
                           vestments are fully taxable to
                           owner.

    . Partnership          Dividends taxable to individual
                           partners.  See proprietorship,
                           above.
@CODE: AL AZ AR CO DE FL GA ID IL IN IA KS LA MD MI MN MT NB NV ND OK RI SD TX UT VA WV WY

    . Lim. Liability Co.   Dividends taxable to individual
                           members, if treated as  partner-
                           ship for tax purposes.
@CODE:OF

    . Regular Corporation  Dividends are taxable to the cor-
                           poration. But aäspecial deductionè          \245
                           is allowed for 70% of the divi-
                           dends received, generally (unless
                           stock is purchased with borrowed
                           money), an important tax advan-
                           tage.

    . S Corporation        Dividends are taxable to indiv-
                           idual shareholders of the S cor-
                           poration, as in the case of divi-
                           dends received by a partnership.