Taxation and personal income in an S Corporation or LLC

Hi Craven,

I run an S Corp. My understanding is that once you incorporate you would need to use personal funds as a loan to the corporation or as additional investments in your base capital by increasing the number of corporate shares on the books. Your loss is limited to the amount of the base capital. The corporation provides me with a K-1 form at the end of the year to use to calculate my personal taxes. Profits are taxed as income, losses are credited within the limits above. I use an accountant for my corporate taxes so I'm not positive of all that goes in to determining the profit or loss on the K-1. I know it takes capital depreciation into account but I'm not sure what else.

Each December I go through an exercise of balancing out my corporate accounts to make sure I don't have any excess profits hanging around. I pay myself a bonus, if necessary, to move money out of the corporation so that it isn't taxed twice, first as profit, then ultimately as income.

Hmm, I still don't understand whether or nor my personal income that I use for Able2Know would be deductable under that scenario.

Do you know if it can?

I'm not sure, exactly. My understanding is that under an SCorp your personal income can only be used as a loan or as an increased capital investment so no, I don't think it would be deductable. Think of it as if you were investing in someone else's company, the investment or loan amount wouldn't be deductable, but the interest earned would be taxed. I've got a reference book here somewhere on the various rules for incorporating or setting up limited partnerships. I'll try to find it.

Hmm, you did help me in that you made me think to ask some accountants at work (I was in a legal mindset for the questions and was thinking of asking a lawyer).

Let's see what they say.

Can't recall all of the advantages one way or the other but I would recommend incorporation in Delaware -- there's a reason why so many companies do just that. The laws are favorable and the court system knows what they're doing vis a vis corporations.

Yup, I've been looking at Nevada and Delaware for those reasons.

Nevada seems to benefit smaller corporations to a greater degree than Delaware though and it's closer to me (probably won't make a difference unless it's a venue).

You can deduct losses to the S Corporation to the extent you loan money to the corporation, and that would be on top of your basis in your stock. For instance, if you purchased your stock for $5,000 and loaned the corporation another $5,000 that year, and the corporation loses $10,000 in its first year, you can deduct $10,000 that year based on your $5,000 cash contribution, and your $5,000 personal loan.

As you said, if you're considering a foreign incorporation, I would suggest you review the advantages of incorporating in Nevada. Delaware has historically been a good place to incorporate, but many states have adopted the Delaware model. Recently, however, Nevada has become known as "the" place to incorporate.

I clearly need to learn more about business insofar as stocks etc are concerned.

For example, if I incorporate I will likely be the only stockholder (I don't think anyone else is interested in buying into an initial loss) and wonder how I would sell stock to myself...

You can pick up a package at OfficeMax that has everything you need, including blank stock certificates. I used an attorney to file my Articles of Incorporation with the state and to act as the Registered Agent for my business. He gets the annual franchise tax form from the Sec'y of State and sends it on to me for payment. I'm not positive why I needed an attorney to act as Registered Agent, but supposedly I do. I used an accountant to help get my FEIN and IL tax ID numbers. I still use an accountant for my business taxes even though I do my own personal tax returns.

Easy ... let me give you an example of what might happen. Of course you must check the laws of the state where you eventually decide to incorporate:

You would be the incorporator, and you would draw up the Articles of Incorporation and Bylaws. You would file the Articles with the Secretary of State, often electronically. As the incorporator, you would name the initial board of directors (you) through an Action of the Incorporator form.

You would next prepare a waiver of notice of a First Organizational Meeting of the Board of Directors -- or you could serve yourself notice ... your choice. At the date set for the meeting, you would meet with yourself and would approve and adopt the Bylaws, and ratify the actions of the Incorporator (you). You would nominate officers to serve on the Board until successors are chosen: President (you), Secretary (you), and Treasurer (you). At that meeting you would offer to transfer property or other consideration to the corporation in exchange for a certain number of shares of common stock (equaling 100% of the corporate stock). The Board would accept the offer, and authorize the issuance of a stock certificate of fully-paid, non assessable capital stock in the certain number of shares.

You would then prepare a waiver of notice of your First Shareholders Meeting and First Board of Directors Meeting.

At the Shareholders meeting you would, inter alia, review and adopt the Bylaws, ratify the election of the members of the board of directors (you), and ratify all actions and decisions made at the Organizational Meeting of the Board.

At the First Directors Meeting, you would approve the minutes of the Organizational Meeting, ratify the election of officers to the Board done at the Organizational Meeting, approve the opening of a bank account, establish the fiscal year of the corporation, establish the fixed date of meetings (probably just a required annual meeting), resolve that all officers are authorized to do any and all things necessary to conduct the business of the corporation as set forth in the Articles of Incorporation and Bylaws, etc.

You will continue to meet regularly, at a minimum once a year. The date of the annual meetings should be stated in your Bylaws. You must prepare minutes of your meetings, and keep them in your corporation notebook. You will conduct your operations fully aware that your corporation is a distinct legal entity. If you sign checks or other legal documents in the capacity of an officer of the corporation, you will sign: "Craven de Kere, President." That is very important.

Nothing to it but to do it.

Are you SURE people wouldn't buy stock?

Especially with the knowledge that once you had that cash infusion, you could do bigger and better things with already quite-big A2K?

Hmm, I don't plan to use an attorney for my registered agent. The requiremens I have seen are merely a resident and adress (non PO box).

Thanks Tico, while in the shower I thought that perhaps I could sell stock (post incorporation) to myself by increasing the shares. Is that right?

Dunno, I don't much like the idea of being responsible for other people's money in A2K just yet.

I don't really run A2K with profit as the goal, so I feel that selling stock would either be a bad deal for others or it would mean that I would have to do so out of responsibility to shareholders.

In the future, if A2K can show steady, sustainable, and growing profit then I would be interested. But I'm at a point where I am even considering incorporating as a non-profit.

That makes sense.

If it is something that could be self-fulfilling, though -- if you had enough money, you could make it profitable (even if the profits would be down the line) -- I bet a lot of people would be interested.

Yes, you could (but remember: you aren't selling to yourself; the corporation is offering the shares to you). You don't need an attorney to be the Registered Agent, but you do need a resident. There are companies that provide these services for a nominal fee, if you don't know someone who lives in Nevada.

Yup, so far it seems to cost about $150 a year for the registered agent.

Effin' pain in the ass dis business.

Keep looking, Craven. I'm certain you can get that down to $100 or less, with a reputable company.