Can a one-man C-corp make sense?

A close relative is giving consulting a try. For now she's operating as a vanilla sole proprietor to minimize the red tape until she decides if it's going to work out and be
sustainable/profitable. If she decides it does, she'll certainly talk to a lawyer and a tax pro before messing with entities. But in the meantime we're trying to get some perspectives on different forms of business. The most common info one tends to read seems these days to recommend operating as a sole prop, as an S-corp, or as an LLC that chooses to be taxed as a sole prop or an S-corp. However, the other day we were reading an interesting book by Nolo Press on business structure that made some pretty interesting arguments for a one-man operation organizing as a C-corp instead of an S-corp (if you're not going to be a sole prop or disregarded entity). Some of the author's arguments:
* For a one-man operation, an S-corp doesn't give much of a chance to avoid payroll taxes because pretty much all the profit has to be taken as wages. * For a one-man operation, the double-taxation a C-corp brings into play can be made mostly irrelevant if most/all of the profits are taken out as wages, making a C-corp no worse than an S-corp if you go that route. * However, with a C-corp you have the option to not take out all profits as wages. The remainder will indeed be taxed at the corporate level, but then this gives higher bracket people the ability to split their business income between themselves (as wages) and the corporation (as corporate profits) and get the first $50,000 of corporate profits taxed at only 15%. While those profits will eventually be subject to a second tax when they ultimately come out, that can be deferred indefinitely, may be at a low rate (as qualified dividends), or can be paid out as wages in years when you are personally in a low bracket. * A C-corp gives full fringe benefit flexibility, allowing access to plans and fringes that are disallowed to sole proprietors or to S-corp owners. On the downside, it's also more complicated, may subject you to state corporate minimum taxes, may cost more to set up, have higher compliance and filing costs, etc. Comments?
-- Rich Carreiro snipped-for-privacy@rlcarr.com
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There are different issues with each type of entity. Each has its advantages & disadvantages. Facts & circumstances will help decide which is most appropriate for your situation. You should consult your CPA/tax advisor to help determine which one works best for you. ___________________________________ <<< Benjamin Yazersky, CPA [NJ & NY] >>> -----> real address on hobokeni or hobokenx <-----
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snip

The author is probably right but in reality many pay only part as wages and part as distributions.

The author is assuming that the C-corp will be on top of its accounting enough to zero out profits at year-end. Many small business owners don't even know their bank and credit card balances.

Currently the qualified dividend break is scheduled to expire. I also seldom see a successful consultant dropping into a lower bracket. It does happen though, especially when rates are cut. Besides the "bonus the profit" out method takes care of the problem if done correctly.

Mostly this is true. In some areas a solo will still not get a benefit. For example for a dependent care plan the owner cannot receive more than 25% of the benefits.

I don't think it will typically be more complex to setup than an S nor should compliance costs vary that much. It will be the planning that adds to the expense either in time or money or both. -- Drew Edmundson, CPA Cary, NC
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We've never bought into this argument.

Because of the above, this becomes a factor for our clients.

If the corporation isn't close to zero before taxes, you will pay a second tax to get the money. It can be dividend double taxation or it can be FICA and income taxes, but there will be a second tax.

The only fringe we've found worth discussing is medical reimbursement plan. If your relative has young children, or significant out of pocket medical expenses this can make the payroll issue work.

It shouldn't cost any more to set up than an S-Corporation, isn't any more complicated than any other business entity, has no higher compliance or filing cost than any other business and works well in the appropriate circumstances. If the business is not a personal services corporation, it can also use a fiscal year, which allows for income games. The only additional expense we've consistently seen is the year end meeting which has to be detailed in order to make the corporate taxes minimal. There are some state issues, but not as many as you might think. -- Bruce Davidson Cantor, CPA, JD Admitted in Colorado
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You've piqued my interest.
Out of curiousity, is your rationale economics-based (i.e. a theory about the nature of the income the owner-employee is earning and the services he provides to the corp that support only some of profit coming out as wages) or is it empirically-based (i.e. history shows the IRS doesn't challenge S-corp dividends of less than X% of profits, so take an X% of profit dividend), or a mix? -- Rich Carreiro snipped-for-privacy@rlcarr.com
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Rich Carreiro wrote:
(snchipped...)

And Rich, you've piqued MY interest, now. As one who has a lot of clients with S corporations, ... advocates the virtues of S corporations, and who operates that way myself, just what is the value of X above? (grin) ChEAr$, Harlan Lunsford, EA n LA
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If the income of an S-corp shareholder is greater than a "reasonable amount" that would be paid to a regular employee who could have done the job, the excess does not have to be recognized as salary subject to self-employment taxes. A lot of the time there would be little or no savings. But for a very successful business it could make a bigger difference. Stu
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Ah -- that makes sense.
-- Rich Carreiro snipped-for-privacy@rlcarr.com
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Economically, we would take the position that the corporation could hire someone to do the job instead of the owner. That new employee would be paid less than the total income, as the owner is going to want some level of return. The new employee would take less than the total income because, if they could make the total income, they wouldn't be an employee in the first place. More realistically, we know that a 0 payroll is not acceptable. The US Supreme Court has so ruled. We know the IRS would like all payroll to be 100% of the net earnings. ANYTHING in between is a gray area, and is subject to challenge. Without any economic argument whatsoever, we have over the past three years established a floor of 25% of income before payroll as a comfort zone. We don't believe the Service is going to bring a case with facts anywhere near that in the S setting. To do so would be to establish a new floor, which would ultimately lower revenues. Congress is aware of this issue, as is the Service. There have been proposals floated to close the opportunity. If one of those proposals becomes law, we will immediately be talking to our clients and re-evaluating their positions. Until then, those clients who are comfortable with this level of risk and see the savings as worthwhile are taking advantage of the opening. -- Bruce Davidson Cantor, CPA, JD Admitted in Colorado
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One of the biggest factor for a new venture: as a C-Corp, if it's not profitable, you can't claim the loss--the loss does not pass thru to the owner's individual return. << ------------------------------------------------------- >> << The foregoing was not intended or written to be used, >> << nor can it used, for the purpose of avoiding penalties >> << that may be imposed upon the taxpayer. >> << >> << The Charter and the Guidelines for submitting posts >> << to this newsgroup as well as our anti-spamming policy >> << are at www.asktax.org. >> << Copyright (2007) - All rights reserved. >> << ------------------------------------------------------- >>
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Rich Carreiro wrote:

Question. This one woman corporation wouldn't happen to be in a profesion that might be subject to the PSC rules, eh? ChEAr$, Harlan Lunsford, EA n LA
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Good question. Software engineering consultant.
-- Rich Carreiro snipped-for-privacy@rlcarr.com
Moderator: C-Corps are one way around the arbitrary, capricious, and dispicable Section 1706 of the 1986 Tax Act.
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In our opinion, that's a PSC.

Which is what? According to my materials, Code Section 448 was added by Section 801 of the '86 Tax Act. Further, C Corps are the only entities subject to the PSC regime. To avoid PSC taxes, some professionals specifically elect S status. -- Bruce Davidson Cantor, CPA, JD Admitted in Colorado
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Rich Carreiro wrote:

Ahah. Now here's how IRS defines what constitutes "services' in such a case "Personal services. Personal services include any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts." Looks like an S corporation would get around this.

Just how despicable IS that section 1706? IOW, what does it say? (grin)
ChEAr$, Harlan Lunsford, EA n LA
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