Tax Effects And Ownership Interest/Business Finance – Accounting
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Running head: BUSINESS ENTITY, ACCOUNTING METHOD, AND TAX LAWS
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BUSINESS ENTITY, ACCOUNTING METHOD, AND TAX LAWS
Business Entity, Accounting Method, and Tax Laws
Robert Shulzinsky
17 September 2017
Business Entity, Accounting Method, and Tax Laws
Entity selection is a vital decision that business owners must make. Business incorporation comes with different tax ramifications that need to be considered when making the decision. Business owners need to consider both the tax and the nontax implications where they decide the most appropriate business structure to come up with. However, they should not only take into account tax considerations since other crucial factors need to be considered when developing a business. In this case, Bob should not operate as a sole proprietorship since he is required to report the entire business income on his income tax return. It means that Bob will pay more tax which will be expensive to the firm.
Incorporating the business will be substantial in formalizing the business and separating its activities from Bob’s activities. Incorporation will allow Bob to increase latitude in succession planning. Bob will also be able to protect his assets and investments from creditors and the business entity. However, due to the different taxation policies between an S corporation and a C corporation. Due to the nature of the business and ownership structure of Bob’s business, the most appropriate business structure for taxation purposes is the S corporation (Cordes et al., 2005). According to the IRS tax regulations, an S corporation is treated as a partnership for taxation purposes. An S corporation is a limited liability company meaning that it is not liable for income tax. It does not have the corporate level tax. The revenue and losses of an S corporation are distributed to shareholders from where they are taxed based on their allocated income. It is known as a pass-through entity.
Due to the taxation effects of an S corporation, Bob will be required to maintain accurate records of their incomes and investments. These are reported at the corporate level and are crucial in the allocation process to the company’s shareholders. Therefore, the most efficient accounting method to be adopted by Bob’s car business is the cash method. It is because the business needs to maintain accurate records for each shareholder for taxation purposes.
Registering the car business as an S corporation will be vital in minimizing double taxation effects. According to the firm structure, the business pays both Bob and his daughter annual wages. Based on the S corporation taxation requirements, both Bob and his daughter will not pay the self-employment tax on their allocation on business profits (Kahn et al., 2013). It is a crucial employee benefit since there will be no deductions from their annual salaries received from the firm.
There are various tax benefits associated with S corporation. Bob and his business will only be liable for a single taxation. All the business earning and losses are passed onto the shareholders who are taxed directly. The resulting tax liability is assessed and paid at the individual level. The losses that might be incurred by the business are applied to other business incomes which in turn reduces the tax liability of individual shareholders. There is no payment or other forms of taxes by the business which results in tax savings. S corporation splits the income meaning that shareholders will not be eligible for deductions on their payroll.
References
Cordes, J., Ebel, R., & Gravelle, J. (2005). The encyclopedia of taxation & tax policy. Washington, D.C.: Urban Institute Press.
Deciding whether to elect to be an S corporation after the ’86 Tax Reform Act. (2006). New York.
Kahn, D., Kahn, J., & Perris, T. (2013). Taxation of S corporations in a nutshell.
