Poznak Law Firm LTD
  1. SOLE PROPRIETORSHIP
    1. Definition
      1. business owned by one person
      2. legal existence of proprietorship is extension of proprietor
      3. may have any number of employees
      4. employee differs from indepedent contractor
      5. may do business under a tradename
    2. Formation
      1. obtain required state, county, and local licenses
      2. obtain federal employer indentification number if engage employees or independent contractors
      3. if engage employees:
        1. obtain workers compensation insurance
        2. file form UI-1 with Illinois Department of Employment Security
        3. file form REG-1 with the Illinois Department of Revenue
      4. verify existence of similar tradenames
      5. register tradename in County where business located
      6. investigate State of Federal trademark registratoins
        1. cannot register trademark until operation begin
      7. consider copyright registration
      8. begin operations
    3. Advantages
      1. avoid state corporate income tax
      2. ease of formation
      3. no double taxation of income or gain from sale of business assets
      4. deductions for ordinary and necessary business expenses and deductions for losses taken by owner personally to extent of other income (including spouse's income if reported on joint return) and without any basis limitation
    4. Disadvantages
      1. unlimited liability of owner, including liability for acts done by employees in furtherance of proprietorship business
      2. no avoidance of Self-Employment tax
      3. certain fringe benefits unavailable:
        1. deduction for health insurance: 45% - 80% from 1997 - 2006
        2. no exclusion for $50,000 life insurance
        3. no exclusion for employer-provided group legal services
      4. cannot take maximum pension and profit sharing
      5. may be viewed as unsophisticated by vendors or customers
      6. top tax bracket is higher than corporations
  2. CORPORATION
    1. Definition
      1. an entity created by a state stature known in Illinois as the Business Corporation Act
      2. exists separately from and independently of the owners
      3. may have one of more owners
      4. owners are called shareholders or stockholders
      5. ownership evidenced by stock certificate
      6. may have any number of employees
      7. employee differs from independent contractor
      8. must do business under a tradename
    2. Formation
      1. select tradename
      2. prepare and file articles of incorporation with Secretary of State
      3. record articles of incorporation in County where agent located
      4. obtain federal taxpayer identification number
      5. file initial reports with Departnemt of Revenue and Unemployment Commission
      6. hold initial shareholders' and directors' meetings
      7. prepare and execute shareholders' agreements
      8. obtain required licenses
      9. consider State or Federal registration of tradename
      10. begin operations
    3. Advantages
      1. limited liability, provided --
        1. sufficient equity
        2. observe corporate formalities
      2. 100% deduction for health insurance
      3. exclude 50% of gain on sale of stock (if original issue and held five years)
        1. unavailable for business in which the principal asset is the reputation or skill of one or more employees (such as doctors, lawyers, accountants, financial planners, and other consultants)
      4. take ordinary loss deduction on sale or exchange of stock, up to $50,000 ($1000,000 if filing joint return)
      5. exclude cost of $50,000 life insurance
      6. maximum pension and profit sharing
      7. different classes of stock
      8. perceived to be sophisticated form of business
      9. top tax bracket is lower than top individual bracket
    4. Disadvantages
      1. no avoidance of Social Security tax
      2. 7.3% state corporation income tax on income above $1,000
      3. double tax
        1. reasonable amount of income can be "zeroed out"
        2. "excess" profits subject to divident treatment or accumulated earnings tax
        3. gain from sale of business assets may be trapped
      4. deductions for ordinary and necessary business expenses and deductions for losses taken only by corporation, not by shareholders personally
      5. automatic dissolution for failure to file annual report
    5. S Corporations
      1. characteristics
        1. generally same as a regular corporation
        2. created and exists under Subchapter S of the Internal Revenue Code
          1. maximum 35 shareholders
          2. husband and wife count as one shareholder
        3. shareholder may not be nonresident alien, another corporation, or most trusts
      2. Formation
        1. unanimous shareholder consent required
        2. first year -- file election with IRS within 75 days after commence business
        3. after first year -- file election with IRS by 15th day of 3rd month of tax year
      3. Revocation of Election
        1. automatic if any event occurs that would have initially barred election
          1. effective upon date event occurs
        2. by unanimous shareholder consent

effective upon date specified by shareholders or if none specified, retroactive to first day of current tax year if made before 15th day of 3rd month or prospective to first day of next tax year

        1. effect of revocation
          1. may not reelect S status without IRS consent
          2. short tax year
      1. Advantages
        1. same limited liability as regular corporation
        2. state corporate income tax is lower than a regular corporation
        3. possible partial avoidance of Social Security tax
        4. no double taxation of income or gain from sale of business assets
        5. losses may be deducted personally by the shareholders in proportion to their ownership interest, subject to basis limitations
      2. Disadvantages
        1. 1.5% state corporate income tax on income above $1,000
        2. one class of stock
        3. inflexible allocatoins of income and losses
        4. may be accumulated earnings tax if regular corporation operated for one or more years before making election
        5. deduction for health insurance: 45% - 80% from 1997 - 2006
        6. cannot take maximum pension and profit sharing
        7. exclusion of %50 of gain on sale of stock if held for five years is unavailable
        8. exclusion for $50,000 life insurance unavailable
        9. shareholders taxed on share of profits whether or not distributed
        10. top tax bracket is higher than top corporate bracket
  1. PARTNERSHIP
    1. Definition
      1. business owned by at least two people
        1. corporation can be a partner
      2. legal existence of partnership is extension of partners
      3. may have any number of employees
      4. employee differs from independent contractor
      5. must do business under a tradename
    2. Formation
      1. see rules for sole proprietorship
    3. Advantages
      1. no double taxation of income or gain from sale of business assets
      2. deductions for ordinary and necessary business expenses taken by partners personally to extent of other income, subject to basis limitation
      3. flexible allocations of items of income and deductions
    4. Disadvantages
      1. unlimited liability of general partners, including acts done by other partners or employees in furtherance of partnership business
      2. no avoidance of Self-Employment tax
      3. 1.5% state income tax on income above $1,000
      4. deduction for health insurance same as sole proprietor
      5. cannot avoid any Social Security tax
      6. exclusion for $50,000 life insurance unavailable
      7. partners taxed on profits whether or not distributed
      8. partnership agreement strongly recommended and essential if partners desire special allocations of income or deductions
      9. complex accounting
      10. top income tax bracket is higher than top corporate bracket
    5. Types of Partnerships
      1. general partnership
        1. apply above rules
      2. limited partnership
        1. general and limited partners
          1. general partners
            1. management and control
            2. usually a corporation
            3. apply above rules
          2. limited partners
            1. usually investors
            2. liability limited to amount of investment
            3. at risk and passive loss rules may further limit deductions
        2. formation
          1. partnership agreement strongly advised
          2. Federal and State securities disclosures and registration requirements
  2. Limited Liability Companies
    1. Definition -- a corporation taxed as a partnership
      1. Illinois statute effective on January 1, 1994
      2. already exists in several other states and may now be used in Illinois
    2. Advantages
      1. avoids use of limited partnership to structure deal with non-resident aliens that require special allocations or flow-through of gain and loss
      2. structure deals that could not be done through S Corporations due to identity or number of shareholders or single class of stock limitations
      3. structure deals that would be cumbersome through use of partnership having S Corporations as partners due to the large number of participants
    3. Disadvantages
      1. must be carefully organized to ensure partnership tax treatment
      2. not widely used ,so corporate shield may not always be upheld in states that do not yet have a limited liability corporation statute
      3. same income tax disadvantages as partnerships

Copyright 1997
Poznak Law Firm Ltd.