More on corporation election: S,C or LLC

Here is a follow up by tax expert Mitch Reitman.  It's a bit complex so let
me simplify it.  The preferred entitly for conducting your alarm business
is a sub chapter S corporation.  If your accountant or tax attorney
recommends anything else, show them this email.



Ken,

Lilianne is correct.  I recently picked up a client that was a California
LLC.  How this got past the California Bureau of Consumer Affairs I don't
know.  This is a good example of why you should use professionals that
understand the alarm industry.  They were a partnership and had to convert
to an S Corporation which posed some additional challenges.

 A few things to note about a LLC from a tax perspective.  Remember these
are not legal issues, simply Federal tax treatment issues.  An LLC can be
taxed three different ways.

 A LLC can be taxed as a C Corporation (if the members formally elect this
treatment).  This is rarely if ever a good idea and I have never seen a
closely held alarm company do this.  Remember, this does not make the LLC a
corporation, it only taxes it as one.

 1. A LLC with more than one member is taxed as a partnership.  This is the
    typical tax treatment of a LLC.  Partnership taxation can be tricky,
    especially if majority partners leave.  The most common reason for
    multiple entities to form an LLC as opposed to a Corporation as that a
    Corporation or LLC can be a member of another LLC, while Subchapter S
    Corporation stockholders generally must be individuals or trusts.
 2. A LLC with one member is taxed as a sole proprietorship.  The owner
    would not file a separate tax return for the LLC.  The tax form would
    be a Schedule C attached to the owner's personal tax return.
    Contrary to popular belief, a single member LLC cannot file a
    partnership tax return (Form 1065) as a partnership must have at least
    two members.  I have actually seen an instance in which a tax preparer
    has filed 1065's for a single member LLC.

I strongly discourage my clients from forming LLC's as opposed to S
Corporation.  The 2004 tax law lifted many of the restrictions  on S
corporations (raised the number of shareholders to 100, etc..) and other
recent tax changes allow owners to deduct their personal health insurance
expense.  An S Corporation may repeat may be able to issue non-voting stock
as long as the only difference between the classes of stock is voting
rights (check with your tax advisor prior to doing this as violating the S
Corporation rules may automatically revoke the S Election resulting in
automatic C Corporation status).  This is especially useful for a business
owner that wants to provide some equity to employees or others, but does
not wish them to be able to vote on corporate affairs.

I also discourage single member LLC's for another reason.  This is pure
supposition but it is well grounded.  The IRS uses many methods to select
audit targets, one of which is DIF scoring.  While the IRS is vague as to
how DIF scoring works, they have agreed that it matches tax returns of
individuals and entities with similar characteristics and compares line
items of their tax returns in order to detect fluctuations.  A small alarm
company with gross revenue of $700,000 and net income of $650,000 would be
in the top percentages of sole proprietorships and stand out from the
crowd.  That same company would reflect an average S Corporation.
Most CPA's do not understand the value of recurring monthly revenue to an
alarm company.  I testify as to valuations in divorces, and partner
disputes across the country and the opposing CPA's are clueless.  The
taxation on the sale of RMR by a C corporation can approach 50% on a
corporate and personal level.  Most CPA's only know their clients by
their tax returns and have no idea that this huge intangible asset is out
there.  The conversion from a C Corporation to an S Corporation (for an
existing corp) is complicated and the tax benefits on a sale may not be
available until ten years have passed.

 Mitch Reitman

S.I.C. Consulting, Inc.

307 West Seventh Street

17th Floor

Fort Worth, TX 76102

817-698-9999

WWW.SICC.US