@Q01 旼컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� � TO INCORPORATE OR NOT TO INCORPORATE: � � THE PERENNIAL QUESTION � 읕컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴컴� Please enter the name of your business (or your proposed business): @TX 01\Q02 @Q02 QUESTION: Is this a business that you have already started (or acquired)? @YN 01\Q03 02\Q10 @Q03 QUESTION: If you were to sell your business (or the stock of your incorporated business) today for its fair value, how much of a taxable gain or a loss would you have on the sale? (Make your best guess.) . 1 - A gain of over $1 million . 2 - A gain of $500,000 to $1 million . 3 - A gain of $100,000 to $500,000 . 4 - A gain of $50,000 to $100,000 . 5 - A gain of about $0 to $50,000 . 6 - Breakeven, more or less . 7 - A loss of less than $50,000 . 8 - A loss of $50,000 to $150,000 . 9 - A loss in excess of $150,000 @MC\09 01\Q04 02\Q04 03\Q04 04\Q04 05\Q04 06\Q04 07\Q04 08\Q04 09\Q04 @Q04 QUESTION: Is the business in question already incorporated? @YN 01\Q05 02\Q10 @Q05 QUESTION: Is the corporation an "S corporation"? @YN 01\Q06 02\Q22 @Q22 NET OPERATING LOSS OR TAX CREDIT CARRYOVERS: A C corporation that incurs net operating losses or has more tax credits than it can use in the current tax year can generally carry the losses or unused tax credits back to any of its 3 preceding tax years, to obtain refunds of taxes paid in those years. However, for a new corporation, or one that has no profitable prior years to carry losses or credits back to, there is no other choice but to carry the net operating losses (NOL's) or credits over to future years, in the hope that it will even- tually have taxable income against which the NOL or credit carryovers can be offset, reducing taxes in those future years. (Most NOL's or unused tax credits can be carried for- ward for up to 15 tax years after the year incurred.) QUESTION: Does your C corporation have substantial unused net operating loss or tax credit carryovers at present? @YN 01\Q06 02\Q06 @Q06 TAX LOSSES: Start up losses incurred by a regular ("C") cor- poration cannot be passed through to shareholders, but must be carried forward until (if ever) they can be used to off- set future taxable income of the corporation....And a more- than-50% change in stock ownership of the corporation can severely reduce the corporation's right to use a large part of any such tax loss carryovers. An S corporation election can be very useful in the early sta- ges of a business if it is losing money, due to the fact that the losses an S corporation incurs can be "passed through" to its shareholders and, in many cases, deducted on their indiv- idual tax returns. An S corporation can also pass through cer- tain tax credits, such as the targeted jobs credit and various other business credits, which might not be utilized currently in a C corporation that has little or no net taxable income. QUESTION: Is your corporation generating tax losses (Or do you expect it to?) in amounts you consider substantial? @YN 01\Q21 02\Q07 @Q21 The usability of your corporation's tax losses, even if it is an S corporation, depends upon whether those losses (and/or tax credits) can be passed through and utilized by the stock- holders. Thus, such losses may not flow through to your indi- vidual tax return if, for instance, they are "passive activi- ty" losses; you or the S corporation are not considered "at- risk" with respect to the losses; or you lack sufficient "tax basis" in your S corporation stock to utilize any further losses. Or, even if the losses or credits flow through to your individual return, you may not be able to use them cur- rently, due to insufficient taxable income of your own in the current year (or preceding 3 years) against which the losses can be applied, or else credits may not be usable by you due to such factors as the alternative minimum tax (AMT). QUESTION: To the best of your knowledge (only your tax adviser can tell you for sure about this one), do you think you could utilize your corpora- tion's tax losses if it is an S corporation? @YN 01\Q12 02\Q12 @Q07 QUESTION: How much annual PRE-TAX profit do you expect the corporation to earn each year in the near future (assuming you limit owner salaries to no more than $100,000 a year per owner, as a maximum) ? . 1 - None: We expect to have losses, or very minimal net profits, under $10,000 (as defined above) . 2 - Between $10,000 and $100,000 profit (as defined above) . 3 - Between $100,000 and $335,000 profit (as defined above) . 4 - Over $335,000 pre-tax profit (as defined above) @MC\04 01\Q12 02\Q12 03\Q12 04\Q12 @Q10 TAX LOSSES: Start-up or other losses or tax credits earned by an unincorporated business (a sole proprietorship or part- nership) can generally be passed through to the owner or ow- ners, to be claimed on their individual income tax returns. (Unless the deductions or credits are suspended due to at- risk or passive activity loss rules, or on account of insuf- ficient tax basis.) Such losses or credits cannot be used if the legal form of the business is a C corporation, but must instead be carried over to another year in which the corporation has taxable income. QUESTION: Will your business generate tax losses or tax credits in the next tax year (or two), in amounts that you consider substantial? @YN 01\Q12 02\Q11 @Q11 QUESTION: How much pre-tax profit (per owner, if more than one owner) do you expect the business to earn, on average, for the next few years (assuming the business is not incorporated)? . 1 - None: We expect to have losses, or not over $50,000 profit (as defined above) . 2 - Between $50,000 and $100,000 profit (as defined above) . 3 - Between $100,000 and $335,000 profit (as defined above) . 4 - Over $335,000 pre-tax profit (as defined above) @MC\04 01\Q12 02\Q12 03\Q12 04\Q12 @Q12 Medical insurance, medical reimbursement plan expenses, and other "fringe benefits" such as disability insurance and group-term life insurance are generally not deductible expen- ses for owners of unincorporated business or shareholders (owning 2% of the stock or more) of S corporations. By con- trast, a C corporation that pays for such benefits for its employees, including owner-employees, is generally able to deduct such expenses, with the value of such coverage gener- ally NOT being taxable to the employees (except for the value of group-term life insurance coverage in excess of $50,000 for a given employee). QUESTION: Do you (or does your business) plan to purchase medical coverage, disability insurance or group- term life insurance for you or the other owners of the business? @YN 01\Q20 02\Q20 @Q20 DIVIDENDS-RECEIVED DEDUCTION. A C corporation may sometimes be used advantageously to hold dividend-paying stocks, since the federal tax law allows the corporation to avoid paying tax on 70% of the dividends it receives (80% if your company owns 20% or more of the stock of the company paying the divi- dends). This deduction is NOT allowed to an S corporation that gets dividends. Putting securities in your corporation is not always a wise idea, however, despite the 70% dividends- received deduction. Taking the stocks (or proceeds from their sale) back out of your corporation can result in taxable gains at the corporate level and dividend or taxable gain to you as a shareholder, to the extent of the value of whatever you take out of the corporation. Thus, it can be costly if the situa- tion changes and you take the stock back out of the corporation. QUESTION: If you have significant dividend income from stocks, and in light of the foregoing discussion, would you be likely to benefit from the dividends-received deduction if your business, as a C corporation, held stocks? @YN 01\Q13 02\Q13 @Q13 QUALIFIED PERSONAL SERVICE CORPORATIONS: Certain personal service businesses, if incorporated and engaged in rendering services in certain fields such as law, health, accounting, actuarial sciences, architecture, engineering, performing arts or consulting, are considered "QUALIFIED personal ser- vice corporations." ("QPSC") (If substantially all the stock is owned by employees or retired employees, etc.) Note that this definition is slightly different from the definition of "PERSONAL SERVICE CORPORATIONS" that applies to determine a corporation's permissible tax year & tax accounting method. A "QPSC" is taxed at a higher tax rate, generally (34% flat rate), than other C corporations (whose tax rates start at 15%). Obviously, this is a major disadvantage of being a QPSC. QUESTION: To the best of your knowledge (we realize this is a VERY technical definition), is your business one that will be considered a QPSC, if operated as a corporation? @YN 01\Q14 02\Q14 @Q14 PENSION PLANS: Both incorporated and unincorporated busines- ses may maintain qualified pension or profit-sharing plans, and the limits on contributions, benefits, etc., are now roughly the same for corporate, Sub S and Keogh (noncorpor- ate) retirement plans. There are a few differences that re- main, however, despite the "parity" rules that generally put corporate and noncorporate plans on an equal footing in 1984. QUESTION: Does (or will) your business maintain qualified pension and/or profit-sharing plans for the owners and employees? @YN 01\Q15 01\Q16 @Q15 BORROWING FROM YOUR PENSION PLAN: The tax law allows a par- ticipant in a qualified pension or profit sharing plan, in some cases, to borrow against his or her account in the pen- sion or profit sharing plan, up to as much as $50,000 in some cases. But such borrowing is effectively prohibited in the case of certain types of qualified pension or profit sharing plans. QUESTION: How important, on a scale of 1 to 5 (with 5 being most important, 1 being least), is the ability to borrow from your company's pension plan to you (or to your co-owners in the business)? @MC\05 01\Q16 02\Q16 03\Q16 04\Q16 05\Q16 @Q16 LIMITED LIABILITY. One reason many businesses incorporate is to limit the liability of the owners, in the event the busi- ness fails. However, for most small businesses, lenders will usually require that the shareholders of a corporation person- ally guarantee repayment of any loans made to the corporation, since the lender is looking primarily to the owners, rather than the assets of the corporation itself, for security. Thus, for many types of liabilities typically incurred by a small or medium-sized business, incorporation will not serve to limit the owners' liability if the business bellies up-- except against unsecured creditors, such as vendors who have extended credit to the business. QUESTION: How important to your business is the ability to limit liability by incorporating (on a scale from 1 to 5, with 5 being VERY important)? @MC\05 01\Q17 02\Q17 03\Q17 04\Q17 05\Q17 @Q17 PERSONAL HOLDING COMPANY STATUS: If your business derives 60% or more of its "adjusted ordinary gross income" from certain types of income, such as rents, royalties, interest or divid- ends, and operates as a C corporation, any net income that it fails to distribute as dividends to its shareholders may be subject to federal "personal holding company tax" of 28%, at the corporate level. This penalty tax does NOT apply to an unincorporated business or to an S corporation; nor to a C corporation unless over 50% of the stock is held (directly or indirectly) by five or fewer people. (A company with 50% or more of its "ordinary gross income" from a single passive cat- egory, such as rents, mineral/oil/gas royalties, copyright royalties, produced film rents, or active business computer software royalties, MAY be able to avoid personal holding com- pany status if various other technical requirements are met.) QUESTION: Based on the brief description above, do you be- lieve your business will be a "Personal Holding Company" if operated as a C corporation? @YN 01\Q18 02\Q18 @Q18 _______________________________________________________________________ @BR\18 01\Q19 @Q19 @STOP @RD\01 RECOMMENDATIONS: Based on your responses to the foregoing questions, the "EXPERT" has come to a tentative conclusion as to which legal form of business appears most advisable in your particular situation. (See below.) CAUTION: The following recommendation has been arrived at by weighing and assigning points to various known factors regarding your business, in an algorithm that attempts to quantify the unquantifiable. Since there are always numer- ous pros and cons in evaluating the optimum choice of legal entity, the process used by the program is a lot like com- paring 3 oranges with 2 apples and concluding which is better. Accordingly, you should not regard the following recommenda- tion as a definitive judgment, since it involves some very subjective choices and conclusions by the author of the pro- gram, and is also based on far less than complete informa- tion about your situation. However, it does represent an serious attempt to model the thought processes the author, an attorney and CPA, would go through in advising a client as to choice of legal entity, based on the key facts just elicited from you. Just remember that, in making "fuzzy" decisions of this type, no computer program is an adequate substitute for the considered judgment of a competent, ex- perienced, and intuitive professional adviser with a full grasp of the facts and circumstances relating to you and your business. RECOMMENDATION AS TO FORM OF BUSINESS: |VAR| @RD\02 RECOMMENDATIONS: Based on your responses to the foregoing question and answer session, the program is unable to ident- ify any clear "Best" choice of legal entity for your busi- ness. While various weightings have been given to each of the three basic entity choices (unincorporated entity, C corporation and S corporation), and points assigned to each alternative, based on the largely subjective rating system devised for this program, there does not appear to be any clearly preferable entity choice in this case. However, for your consideration, we have provided the scores developed in our internal system of analysis. These numbers have no real meaning, and essentially represent an attempt to quantify our "hunches" about the optimum legal entity for your situation, based on the limited data we have on your business. (Note that there is |VAR| difference in the scores we developed, for the first- and second-best choices. Since there is a considerable lack of precision in our "fuzzy logic" methodology on which these scores are based, this one is definitely too close to call.) @RD\03 More useful, in our opinion, will be your consideration of the various pros and cons of incorporation vs. not, C cor- poration vs. S corporation, etc., which are listed below, all of which are derived from our analysis of what you have told us about your particular company. @RD\04 . Operating in unincorporated form is, to begin with, of- ten much simpler and less costly administratively than operating your business as an incorporated entity. @RD\05 And, as you have probably already learned from experi- ence, operating as an S corporation is even more compli- cated than as a regular C corporation, due to the com- plexity of the tax laws governing S corporations and the need for expert accounting and tax help to maintain the S corporation properly. @RD\06 . Since your business expects to incur substantial operat- ing losses for awhile, being unincorporated would give you a better chance to derive some current tax benefit from those losses, providing you (or your co-owners, if any) can personally utilize the losses or tax credits generated. As a C corporation, by contrast, any such losses (or tax credits) as are generated could not be utilized currently (by either the corporation or you), |VAR|. (An S corporation, of course, could generally pass through any such operating losses to the owner(s), much the same as an unincorporated business.) @RD\07 . From the responses you have given, it appears that it could be advisable to consider liquidating your corpora- tion, and recognizing a substantial tax loss on the li- quidation of your stock. Of course, if the loss is treated as a capital loss, you will only be able to de- duct $3,000 a year against your other income (unless you have capital gains the loss could offset). However, if your stock is eligible for "Section 1244 Stock" treat- ment, you may be able to treat the first $50,000 (or $100,000 on a joint return) of any loss on liquidation as an ORDINARY loss, which ought to be fully deductible in many cases. (There are a number of technical quali- fications in order to actually take such a loss, so con- sult a good tax lawyer or other competent tax adviser before concluding that you ought to liquidate your cor- poration, |VAR|.) @RD\08 . You may want to liquidate your C corporation and operate as a sole proprietorship or partnership, or else elect S corporation status, in order to avoid high marginal cor- poration tax rates, which it appears in this case would be |VAR| (Federal), compared to marginal tax rates of about 31 to 33% if the business income were taxed at individual in- come tax rates, rather than C corporation rates. (However, there might be significant taxes to recognize, by the cor- poration upon any such liquidation, so electing S corpora- tion status may be a better tactic.) @RD\09 . It appears that at your company's level of profitability, a C corporation would probably be in a marginal income tax bracket of |VAR|. Thus an unincorporated business would probably save some current federal income taxes, since individuals are taxed at federal income tax rates of no more than about 31% to 33%, as a general rule. @RD\10 . An unincorporated business will also save on Federal and state unemployment taxes on the earnings of the owners, since as owner-employees of a corporation, unemployment taxes would apply to wages or salary paid to the owner-- but no such tax applies to the business earnings of a partner in a partnership or to a sole proprietor, who take a "draw" rather than salary or wages. . Unincorporated businesses do not have to be concerned with the possible double taxation of profits, unlike C corpora- tions (and, to a lesser extent, some S corporations). . An unincorporated business does not have to be concerned with either of the corporate penalty taxes, the personal holding company tax or the accumulated earnings tax, both of which apply only to C corporations. @RD\11 . One other important benefit of starting out a business in unincorporated form is increased flexibility, from a tax standpoint. An unincorporated business can always incor- porate, but if you have already incorporated, liquidating in order to dis-incorporate can give rise to potentially huge capital gains taxes. @RD\12 . Operating as a C corporation can be a real drawback in the case of your business, since you have indicated that your particular type of business is one that may be considered a Personal Holding Company. If so, and you are unable to zero out its income each year through salary payments or other operating expenses, you could be in the grim situa- tion of incurring double taxation on the corporation's net income. That is, not only would the corporation pay tax on its pre-tax income, but there would also be a se- cond tax on the remaining after-tax net income: either the 28% personal holding company tax, or, if all of the after-tax net income is paid out as dividends to the shareholders, individual income tax on the dividend pay- ments. This is not a problem if you operate the business in unincorporated form, or as an S corporation. @RD\13 . Perhaps the most common and pervasive reason for a busi- ness to be incorporated is to achieve some degree of lim- ited liability. While such limited liability may not be absolute, particularly where creditors of the corpora- tion, lessors, etc., require the owners of the corpora- tion to personally guarantee repayment of corporate loans or leases, limited liability can still be a big advantage. @RD\14 You have indicated that limited liability is VERY import- ant for |VAR|. @RD\15 You indicated, however, that limited liability is NOT very important for |VAR|. @RD\16 . Liquidating a corporation where there is a taxable gain on the transaction can be costly, particularly since it is often difficult to determine the fair value of a going concern (and since the IRS may argue that your taxable gain is much larger than you thought it was). Since you have indicated that you would probably have a substantial gain on liquidation of your existing corporation, the re- sulting tax liability you would personally incur is one good reason NOT to dis-incorporate by liquidating. Also, the corporation itself may incur additional tax upon any liquidation if it holds assets (including intangibles like "goodwill" that may not even be on its books) that have a value in excess of their tax basis. @RD\17 . Because you have indicated your business is incurring operating losses, an S corporation would have advantages for you, as compared to a C corporation, since some or all of such corporate tax losses may be "passed through" to you as a shareholders, and thus should be currently utilizable by you in reducing your personal income tax liability. By contrast, start up losses incurred by a corporation cannot be used to offset income, unless car- ried over and used to reduce the corporation's taxable income in future years, when (or if) the corporation ev- entually becomes profitable. A deduction today is usu- ally worth more than a possible deduction some years in the future. @RD\18 . For a business operating at an annual profit level of less than $100,000 or so (after owners' salaries), a C corporation may provide an income-splitting opportunity which can reduce, or at least defer, overall taxes. This can be done by leaving some profit (under $75,000 a year, preferably) in the C corporation, shifting such income out of the owners' 28% or 31% tax brackets into the lower corporate tax brackets of 15% on the first $50,000 and 25% on the next $25,000 of corporate taxable income. This won't work if the corporation is a "qual- ified personal service corporation," which is subject to tax at a flat rate of 34% on all its net income. But you have indicated that the business may have profits of less than $100,000 a year, and that it will not be considered a "qualified personal service corporation" if operated as a C corporation, so you may be able to benefit to some extent from income-splitting by using |VAR| as a second taxpayer. @RD\19 . Unlike a sole proprietorship or partnership, a corpora- tion has continuous existence and does not terminate upon the death of a stockholder or a change of ownership of some or all of its stock. Creditors, suppliers, and customers often prefer to deal with an incorporated busi- ness because of this greater continuity of the enterprise that is provided by the corporate form. Of course, like other forms of business organization, a corporation can be terminated by mutual consent of the owners, or even by one shareholder in some instances. . A corporation also provides advantages, particularly when compared to a partnership, of centralized control, since state corporate laws typically provide rules for election of a board of directors by the shareholders and selection of a president and other corporate officers to manage the everyday affairs of the business, by the board of direc- tors. Lines of authority are usually much clearer and more formal than in the usual partnership arrangement. @RD\20 . The ability of participants to individually borrow against their accounts under a pension plan can be a sig- nificant benefit of having a pension plan for your em- ployees. However, borrowing is allowed only in the case of a "qualified" pension or profit sharing plan of a C corporation. Such borrowing is subject to a "prohibited transactions" penalty tax in the case of a plan main- tained by unincorporated business (Keogh plan) or by an S corporation. You have indicated that the ability of the participants to borrow from your company's pension or profit sharing plan is|VAR| important to you. @RD\21 . The corporate "dividends-received deduction," under which a C corporation (but not an S corporation) can exclude 70% or more of dividends it receives from cor- porate stock investments from taxable income, is a val- uable potential tax benefit of operating a business in the form of a C corporation. You have indicated that this may be an important tax benefit in your case. @RD\22 . The federal tax laws permit corporate employers (except for S corporations) to provide a number of different fringe benefits to employees who are owners (shareholder- employees), on a tax-favored basis. Generally, the emp- loyer is allowed to deduct the insurance premiums or oth- er payments it makes on behalf of the employee, while the employee is not taxed on the value of the benefit provided. Thus, being incorporated (as a C corporation) has important advantages for your business if you wish to obtain group-term life insurance, health/accident coverage (insured or otherwise), or disability insurance coverage for the principals in your business, since you will not be able to obtain this favorable tax treatment as an S corporation, or as a partner or sole proprietor in an unincorporated business, with regard to these kinds of fringe benefit plans. @RD\23 . Because your C corporation has substantial unused net op- erating loss (NOL) or tax credit carryovers, liquidating the corporation would have a major disadvantage: Those NOL or credit carryovers, which might otherwise be used to offset future taxable income of the corporation some- day, would vanish forever if your corporation were li- quidated and turned into an unincorporated business. Also, if S corporation status were elected, those carry- overs would then become useless until after the corpora- tion elected to revert back to C corporation status once again--they cannot be used to shelter any income earned while operating as an S corporation. @RD\24 . You have indicated that your business is a professional service firm. As a C corporation, you will incur a ma- jor disadvantage, since all of the taxable income of a "qualified professional service corporation" is subject to a flat federal tax rate of 34%. This is higher than the top individual tax bracket and a serious disincen- tive to operating a professional firm as a C corporation. @RD\25 _______________________________________________________________________ S CORPORATIONS VS. C CORPORATIONS: Advantages of C Corporations over S Corporations-- . C corporations are generally less complex entities to maintain, from a tax standpoint, than S corporations. . C corporations (except for certain "personal service cor- porations"), can offset losses from passive activities against active business income. S corporations cannot. . C corporations are entitled to the dividends received de- duction on any dividend income they receive; S corpora- tions are not. @RD\26 . C corporations are separate tax-paying entities, so at certain levels of corporate net income, generally under $100,000, a C corporation may be used advantageously to split income, paying tax at rates lower than if the in- come were all taxed to individual shareholders, as in the case of an S corporation. @RD\27 . Shareholder-employees of C corporations have advantages over S corporation shareholders (who own over 2% of the stock) with regard to excluding from income the cost of certain fringe benefits for owners, such as health care coverage, group-term life insurance, and long-term dis- ability insurance. @RD\28 . Owner-employees may borrow from their qualified pension or profit sharing plans, if the plans are sponsored by a C corporation. @RD\29 Advantages of S Corporations over C Corporations-- . S corporations do not usually have to be concerned about possible double taxation of corporate profits, since their profits are generally taxed only once, to their shareholders. . Also, S corporations are not subject to corporate penal- ty taxes, such as the personal holding company tax or the accumulated earnings tax, which apply only to C corporations. @RD\30 . If a new corporation is incurring losses, shareholders of an S corporation may be able to utilize the tax los- ses currently, while a C corporation can only carry the losses over till it eventually (if ever) becomes profi- table. @RD\31 . Conversely, at high levels of taxable income (generally over $100,000), S corporation shareholders may pay tax at a lower rate than a C corporation would pay on the income. @HELP @H\01 Type in the name of your business, then press "Enter" key. @H\02 Enter "Y" ("Yes") if you are already in business. If you are still planning to start or acquire the business, enter "N" ("No"). @H\03 Note that if you were to sell your stock in an S corporation, your tax basis for the stock is likely to be something more or less than your original cost, since income or contributions to capital of the corporation will have increased your tax basis, and tax losses and distribu- tions will have decreased your basis. So you need to use your ADJUSTED tax basis for your stock, not its original basis, in "guesstimating" your gain or loss on stock of an S corporation. @H\04 Answer this question "Y" for "Yes" or "N" for "No." @H\05 An "S corporation" is a corporation that has made an election (on Form 2553) for Federal income tax purposes to have most or all of its income & all of its losses taxed directly to its shareholders, in- stead of paying tax at the corporate level. A corporation that is NOT an S corporation is called a "C corporation." Corporations may also elect treatment as S corporations for state income tax pur- poses, in all but a few states. @H\06 Answer "Y" ("YES") if you anticipate tax losses by your corporation, EVEN IF you anticipate that such losses might not be currently utilizable for some reason, by a C corporation, or if passed through to you by an S corporation. @H\07 In computing your firm's estimated pre- tax profits for the purposes of this question, make the hypothetical assump- tion that each owner will take out no more than $100,000 a year in salary. Thus, for example, if you actually in- tend to take out $150,000 salary next year, add back $50,000 to pre-tax cor- porate income to do this calculation. @H\10 Answer "N" ("NO") if you anticipate sub- stantial losses, or credits but for some reason, such as passive activity loss or at-risk loss restrictions, or insuffici- ent "tax basis," you do not expect to be able to immediately use those losses (or credits) on your individual income tax return. @H\11 In computing pre-tax profit for purposes of answering this question, do not sub- tract draws or salary taken out of the business by you (or by other owners). @H\12 Medical, disability, and group-term life insurance fringe benefits for the owners of a C corporation are treated very fav- orably for tax purposes. Not only is the amount paid for such insurance most- ly nontaxable to the employee-owner, but the benefits (insurance payments, etc.) are generally tax-free to the recipient, as well, except for disability benefits (which are generally taxable to the em- ployee, if the premiums were paid by the corporation). @H\13 To be a QPSC, a corporation must be en- gaged almost exclusively in rendering services in one of the fields listed, and must be "substantially" (95%) owned by its employees, retired employees, or the estate of either (or by an heir, up to 2 years after death). The definition of a Qualified Personal Service Corporation is very complex and difficult to explain to anyone but tax lawyers. At this point, you may wish to exit to the menu of consulting subjects and go thru the Q & A routine on QPSCs. @H\14 Note that a Keogh plan, a Section 401K plan, or an ESOP is a qualified plan. However, an "SEP" ("Simplified Employee Pension plan"), in which the employer contributes to IRA accounts set up on behalf of employees, is NOT considered a qualified plan for purposes of this analysis. @H\15 In general, a participant in a pension or profit sharing plan may borrow up to $50,000 from the plan, but not over the larger of the following two amounts: . One-half of his or her vested benefits under the plan; or . $10,000. An owner-employee is prohibited from borrowing at all from an S corporation plan, or from a Keogh plan (of an unin- corporated business). @H\16 Some types of corporations, such as typ- ical professional corporations in many states, provide little, if any, limita- tion on liability since the laws in many states provide that such corporations do NOT limit liability for claims such as professional malpractice damages, which are a major area of exposure for most types of professional corporations. @H\17 "Adjusted Ordinary Gross Income" is the ordinary GROSS income (excluding capital gains) of a corporation, before any de- ductions, except for certain adjustments applicable to rental income and mineral and oil and gas royalty income (such as depreciation or depletion, property tax, interest and rents paid), and other mis- cellaneous adjustments that apply only to certain kinds of special taxpayers and types of income. @H\20 Note that if your C corporation borrows money to finance or carry its purchases of dividend-paying stocks, in order to benefit from the dividends received de- duction, its interest deduction will be reduced. It cannot deduct interest in- curred to buy tax-free investments. @H\21 Note that losses passed through by an S corporation to its shareholders are not necessarily deductible by a shareholder if the shareholder has used up all the "tax basis" of his stock (plus loans he has made to the corporation). Nor can such losses be used if they are consid- ered "passive activity" losses, and the shareholder does not have income from other passive activities that he can offset the passive losses against. @H\22 Note that your corporation may be very profitable, with significant taxable income and tax liability, and yet may still have significant tax credits that it is carrying forward, due to the com- plex interplay between tax credits and the alternative minimum tax ("AMT") un- der the tax law. Liquidation of the corporation would cause any such carry- overs, as well as any NOL carryovers, to be lost forever. @END