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Author: nickdauber81 Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 121172  
Subject: Incorporate to increase cash available to invest Date: 9/20/2005 9:23 PM
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Hello Fools,

I was wondering if any Fools who happen to be knowledgeful of business law or tax accounting could help me out on this query. I am architecture major at U of Florida. I graduate this fall with a Bachelor's and it will take me another year to complete my Master's and my long term plan is a to amass extensive experience in the field of urban architecture and then incorporate my industry experience into an architectural constancy group with some of my classmates. Who knows how my professional life will change 10 years from now but that is my basic long term goal.

I did take intro. to financial accounting in my freshman year and remember that corporations have this Retained Earnings account whose balance is computed during the closing of every accounting cycle and all cost of goods, returns, allowances, General/Sales and Administrative expenses are deducted from Revenue. After dividends are subtracted from the net gain or [loss] you get the RE balance and list that in the owner's equity section of the balance sheet.

What is the difference between RE and Income for a fiscal year? Does not a business need to pay income tax on both?

Secondly, my cousin had advised me to form a S Corporation if I was doing business on my own for several reasons:

Limited Liability because a corporation is considered a separate legal entity, the shareholders have limited liability for the corporation's debts.

Corporate Tax Treatment. Since a corporation is a separate legal entity, it pays taxes separate and apart from its owners (at least in the typical C corporation).

Owner/Employee. A business owner who works in his or her own business may become an employee and thus be eligible for reimbursement or deduction of many types of expenses, including health and life insurance.

Perpetual Existence. A corporation continues to exist until the shareholders decide to dissolve it or merge with another business.

Freely Transferable Shares. Shares of corporations are generally freely transferable because as a separate entity, the existence of a corporation is not dependent upon who the owners or investors are at any one time. A corporation continues to exist as a separate entity and is not terminated or dissolved even when shareholders dies or sell their shares.

But the drawbacks include:

Fees. It costs money to incorporate. There are typically four types of fees, including: a fee to file the articles of incorporation with the secretary of state; a first year franchise tax prepayment; fees for various governmental filings; and attorney fees.

Formalities. The proper corporate formalities of organizing and running a corporation must be followed in order to receive the benefits of being a corporation.

Paperwork. A huge aspect of the corporate formalities that must be followed consists of paperwork. Reports and tax returns must be compiled and filed in a timely fashion; business bank accounts and records must be maintained etc etc ...

Tax Consequences. C corporations have potential double tax consequences-once when the company makes its profit, and a second time when dividends are paid to shareholders. S corporations can mitigate this tax issue if I am not mistaken.

I think the main difference between type S and C is the number of permissible shareholders, disclosure requirements, scope of liability, dissolution procedures & ability to issue different types of stocks.

I was checking the IRS's website for Self employment taxes and it seems that with the current self-employment tax rate at 15.3 percent, many business owners choose to form an S corporation rather than an LLC. In an S corporation, only shareholders are required to pay self-employment taxes on money paid to them as compensation for services. Also, profits from an S corporation are not taxed.

S Corps can beneficial in that:

1. If your corporation desires to retain earnings, S corporation status can be used to avoid penalty taxes that could be imposed on an unreasonable accumulation of earnings.

2. Tax savings can be realized on all taxable income of the corporation because individual tax rates are lower than corporate tax rates; S corporation status dramatically reduces the potential problem of IRS claims of excessive compensation of shareholder-employees.

3. If your corporation expects to generate capital gain income, the S corporation can make distributions to its shareholders and pass the "capital gain character" of the income directly to shareholders instead of distributions to shareholders otherwise taxed as dividend income.

In a balance sheet, a company will list under or in the current assets sections, various investments and there is also an outflow section in the Statement of cash flows for Investment activities. I was thinking that if one is the sole shareholder of a S Corp they can derive tremendous investment potential by writing off acquisition of stocks as an 'investment outflow of cash' to acquire a 'long term investment'.

You basically defer income taxes by recycling Retained Earnings into an investment expense: buying stocks of other corporations.

That way you have access to money that is pre tax income as opposed to making a withdrawal, paying income taxes and than investing that money.

It makes a helluva of a difference as your business grows and you begin to earn top dollar for your expertise.

Basically you save whatever the tax rate is because it is a business expense and that money compounded over time will result in gains that are multiplicatively greater than when you withdraw the money as income and then use a portion of it to invest after paying the income taxes.

Is this legally permissible and something that is compliant with GAAP?
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