change of business entity type
TRANSCRIPT
Learning Objectives
▪ Explain reasons for changing an entity type.
▪ Determine the process of closing the original business entity.
▪ Explain the process of opening and operating a replacement business entity.
Small Business Entities
■ Sole proprietorship is the most common type.
■ Reasons for a change:□ Liability
□ Change in ownership
□ Taxation
Short Headline
■ Sole proprietor: 100%
■ Partnership: by agreement□ Guaranteed payments
□ Ordinary income
■ S corporation:□ Wages
□ Ordinary income
Allocation of Profits
■ Schedule C (Form 1040) net profit:□ Ordinary income tax
□ Self-employment tax
■ Adjustments to income:□ One-half of self-employment (SE) tax
□ Self-employed health insurance
□ Self-employed retirement contributions
■ QBI deduction
Taxation: Sole Proprietor
■ Ordinary income from Schedule K-1 (Form 1065)
□ Ordinary income tax
□ SE tax
■ Guaranteed payments□ For services: Ordinary income tax and SE tax
□ For capital: Ordinary income tax
■ Adjustments to income□ One-half of SE tax
□ Self-employed health insurance
□ Self-employed retirement contributions
■ QBI deduction□ Not on guaranteed payments
Taxation: Partnership
■ Wages (reasonable salary)
■ FICA tax paid by the employer and employee
■ Adjustment to income□ Health insurance for a more than 2%
shareholder
■ Ordinary income from Schedule K-1 (Form 1120-S)
■ QBI Deduction□ Only on Schedule K-1 income
Taxation: S Corporation
Example
Irene is a sole proprietor or only shareholder of an S corporation.
Her business had a 2020 profit of $75,000.
S corporation reasonable salary = $50,000.
Irene: Schedule C
Net profit $75,000
SE tax $10,597
Adjustment for ½ SE tax $5,299
AGI $69,701
Standard deduction $12,400
QBI deduction $11,460
Ordinary taxable income $45,841
Ordinary income tax $5,872
Total tax paid $16,469
Irene: S CorporationSchedule C S Corporation
Net profit $75,000 $21,175
Wages $50,000
SE/FICA tax $10,597 $7,650
Adjustment for ½ SE tax $5,299 $0
AGI $69,701 $71,175
Standard deduction $12,400 $12,400
QBI deduction $11,460 $4,235
Ordinary taxable income $45,841 $54,540
Ordinary income tax $5,872 $7,786
Total tax paid $16,469 $15,436
■ Ordinary income taxed to the entity at a 21% rate
■ Distributions are taxable dividends
■ Wages (reasonable salary)
■ FICA tax paid by the employer and employee
Taxation: C Corporation
Entity Options
■ Sole proprietorship
■ Partnership
■ S corporation□ U.S. citizens/residents
□ Trusts
□ Nonprofits
□ Other S corps
□ Limit of 100 shareholders
■ C corporation
■ Close the old entity.
■ Create a new entity.
■ Transfer assets.
■ Recognize changes in how the entity operates.
■ Monitor closed business for fraudulent activity.
Entity Transition
Closing a Business■ File final payroll, Forms W-2
and 1099.
■ File final tax return.
■ Close or transfer bank accounts and credit lines.
■ Cancel EIN and IRS business accounts.
■ Retain records.
■ Stop doing business.
■ File the final tax return.
■ Check with the state.
Closing a Sole Proprietorship
■ Check with the state.
■ File the final return and close the business with the state.
Closing a Single-Member LLC
■ Dissolve or transfer.
■ Business should:□ Obtain qualified legal advice.
□ Review the partnership agreement, check state requirements.
■ Dissolve:□ Liquidate assets.
□ Pay debts.
□ Recognize gain or loss.
■ Transfer:□ Assets and basis transfer to the new entity.
Closing a Partnership
■ Revoke the S election or dissolve.
■ Business should:□ Obtain qualified legal advice.
□ Review bylaws, check state requirements.
■ Revoke:□ File a statement with the IRS.
■ Dissolve:□ Liquidate assets.
□ Pay debts.
□ Recognize gain or loss.
Closing an S Corporation
■ Make the S election or dissolve.
■ Make the S election:□ File Form 2553.
□ Rev. Proc. 2013-30.
■ Business should:□ Obtain qualified legal advice.
□ Review bylaws, check state requirements.
■ Net operating losses
■ Dissolve:□ Liquidate assets.
□ Pay debts.
□ Recognize gain or loss.
Closing a C Corporation
Creating the New Business
■ Apply for a new EIN.
■ Choose the tax year and accounting method.
■ Register with the state and local agencies.
■ Stock□ Number of shares
□ Initial stock price
□ Types of stock
■ Business documents
■ File Form 2553 for S corporation election
Creating a Corporation
■ Assets belong to the person, not the business.
■ Determine which assets will be transferred.
■ Contribute assets to the LLC.
■ Contact lenders about debts.
Sole Proprietor to Single-Member LLC
■ Determine adjusted basis and FMV.
■ Options:□ Convert to personal use.
□ Sell to an unrelated party.
□ Sell to the new entity.
□ Contribute to the entity.
Sole Proprietor to Entity
■ Assets over□ Partnership contributes assets to the
corporation for shares.
□ Partnership distributes stock to partners.
■ Assets up□ Partnership distributes assets to the partners
(liquidates).
□ Partners contribute to the corporation.
■ Interests over□ Partners transfer partnership interests to the
corporation for shares.
□ Corporation dissolves partnership.
Rev. Rul. 84-111
Operating a New Business
■ Share management decisions
■ Bookkeeping and accounting
■ Due date of returns