Question

How does the owner compute her basis in a C corp. when she contributes cash, property and services to the corporation?

How does the owner compute her basis in an S corp. when she contributes cash, property and services to the S corporation?

How does the owner compute her outside basis in a partnership when she contributes cash, property and services to the partnership?

You also need to discuss what would cause the owner's basis in her S corp. to increase and to decrease after her initial investment.

You also need to discuss what would cause the owner's outsie basis in her partnership to increase and to decrease after her initial investment.

Additionally, you need to discuss why it is important for the owner to know the amount of her basis in the business. How is her basis used to calculate any gain or loss on her disposal of the business?

Also, how does the owner's basis in her S corp. affect how losses are deductible by the owner?

Also, how does the owner's outside basis in her partnership affect how losses are deductible by the owner?

Answer 1

The C corporation is an often-overlooked option for the small business owner. Choosing to operate as a C corporation can offer structural advantages that the S corporation or other business types such as the LLC cannot. This article explores some of the benefits that a C corporation can offer to its owners, as well as some potential disadvantages.

C Corporation:

A C corporation (also known as a “C Corp”) is a legal entity that protects the owners’ personal assets from creditors. It can have an unlimited number of owners and multiple classes of stock. These characteristics and other advantages make it a good vehicle for attracting venture capital and other types of equity financing. Unlike an S Corporation or an LLC, it pays taxes at the corporate level. This means it is subject to the disadvantage of double taxation. As well, a C corp also must comply with many more federal and state requirements than an LLC.

C corporations provide the following considerable advantages:

• Separate legal identity
• Limited liability for the owners
• Perpetual existence
• Separation between ownership and management
• No restrictions on who can hold shares
• Readily transferable shares
• Well-established legal precedents
• Widespread acceptance by the venture capitalists and other investors
• Ability to offer stock options
• Tax planning opportunities

A Corporation Is Separate from Its Owners

Once formed, a corporation has a life of its own, with its own rights, capabilities, responsibilities, and liabilities. This means that a corporation can sue (or be sued) in its own name. It can buy, own, and use its own real or personal property, make its own contracts and guarantees, lend money and invest funds.

A Corporation Offers Owners Limited Liability Protection

Because a corporation is a separate entity, its debts, obligations, and liabilities are it's own. Those who do business with a corporation must look to the company to satisfy any obligations owed to them, and not to the shareholders. The shareholders' exposure to loss is limited to the amount invested in the corporation.

A Corporation Has a Perpetual Existence

Because a corporation exists separately from its shareholders, it has what’s called a perpetual existence. For example, if the owner of a sole proprietorship dies, the business ceases to exist. This isn’t the case with a corporation., Once a corporation is formed, it continues to exist until it is dissolved, wound up and liquidated, unless its articles of incorporation provide otherwise. What’s more, the transfer of shares of stock has no impact on the existence of the corporation.

The definition of an S corporation is a corporation that is treated, for federal tax purposes, as a pass-through entity through an election made with the Internal Revenue Service (IRS) to be considered an S corporation. S corporations are taxed nder Subchapter S of the Internal Revenue Code (IRC), which is where their name is derived from (Subchapter S Corporation). What does that mean?

As a corporation, an S corporation is created through filing Articles of Incorporation with the Secretary of State or similar government body. It issues stock and is governed as a corporation, with directors, officers, and shareholders who function in the same manner as their C corporation counterparts. The owners (the shareholders) have the same protection from liability as shareholders of a C corporation. An S corporation shareholder’s personal assets, such as personal bank accounts, cannot be seized to satisfy business liabilities.

However, like a sole proprietorship or a partnership, an S corporation passes through most of its income and loss items to the shareholders. Unlike a regular corporation, there is no "double taxation," meaning that the owners do not need to pay taxes twice - once at the corporate level and again on the individual shareholder level. Each shareholder is subject to his or her own individual tax rate on the profits and losses passed through to him or her, recorded as net income on the income tax return.

S corporation:

The advantages of an S corporation often outweigh any perceived disadvantages. The S corporation structure can be especially beneficial when it comes time to transfer ownership or discontinue the business. These advantages are typically unavailable to sole proprietorships and general partnerships. S corporation advantages include:

• Protected assets. An S corporation protects the personal assets of its shareholders. Absent an express personal guarantee, a shareholder does not have personal liability for the business debts and liabilities of the corporation. Creditors cannot pursue the personal assets (house, bank accounts, etc.) of the shareholders to pay business debts. In a sole proprietorship or general partnership, owners and the business are legally considered the same—leaving personal assets vulnerable.
• Pass-through taxation. An S corporation does not pay federal taxes at the corporate level. (Most—but not all—states follow the federal rules. View the Ongoing Corporation Requirements page of our state guides to see if your state recognizes the federal S corporation election.) Any business income or loss is "passed through" to shareholders who report it on their personal income tax returns. This means that business losses can offset other income on the shareholders’ tax returns to reduce income tax paid. This can be extremely helpful in the startup phase of a new business. (A corporation that does not elect S corporation status and accumulates passive income is at risk of being classified as a personal holding company.)
• Tax-favorable characterization of income. S corporation shareholders can be employees of the business and draw salaries as employees. They can also receive dividends from the corporation, as well as other distributions that are tax-free to the extent of their investment in the corporation. A reasonable characterization of distributions as salary or dividends can help the owner-operator reduce self-employment tax liability, while still generating business-expense and wages-paid deductions for the corporation.
• Straightforward transfer of ownership. Interests in an S corporation can be freely transferred without triggering adverse tax consequences. (In a partnership or an LLC, the transfer of more than a 50-percent interest can trigger the termination of the entity.) The S corporation does not need to make adjustments to property basis or comply with complicated accounting rules when an ownership interest is transferred.
• Cash method of accounting. Corporations must use the accrual method of accounting unless they are considered to be small corporations. (A small corporation has gross receipts of $5,000,000 or less.) S corporations, however, usually don't have to use the accrual method unless they have inventory.
• Heightened credibility. Operating as an S corporation may help a new business establish credibility with potential customers, employees, vendors and partners because they see the owners have made a formal commitment to their business.