Catanese & Wells, A Law Corporation provides a quarterly newsletter to the equine industry of and concerning legal, tax and business issues for participants in the horse business or sport. www.cataneselaw.com (https://www.cataneselaw.com).
This issue of the Equine Legal Summary discusses business and tax issues related to the selection of an entity to use in an equine activity whether for profit or not for profit.
There are many forms an equine business can adopt. The business can be a sole proprietorship, a corporation or a partnership. Also, there are hybrid organizations that can be used like a limited liability company which has features found in a corporation and a partnership.
The Internal Revenue Code has Chapter C and Chapter S regarding taxation of corporations. Chapter C generally taxes income at the corporate level and then again when profits are distributed to the shareholders at the shareholder level. This is known as “double” taxation. Chapter S allows for the earnings which occur at the corporate level to go untaxed, but taxation will occur at the shareholder level which avoids double taxation. This type of entity is often times referred to as a “pass through” entity.
Whether the entity is a C Corporation or an S Corporation under state law (which allows for the creation of this legally recognized entity) the corporation will be recognized as an independent legal entity. If created and operated properly, the corporation will allow for asset protection to the individual shareholders by limiting liability to third parties.
A corporation will be taxed as a C Corporation under the Internal Revenue Code unless an election is made by the taxpayer to have the corporation taxed as an S Corporation. In order to qualify for S Corporation status the corporation must have 100 or fewer shareholders (generally only individuals may be shareholders). And, there can only be one class of stock. Generally, the fiscal year must end concurrent with the calendar year or on December 31st. In addition, the stockholders must receive wages paid by the corporation (income may be divided between wages and dividends to limit self-employment taxes).
An S Corporation allows its shareholders the opportunity for income distribution to limit self-employment tax. A sole proprietorship will have self-employment tax on all income. A limited liability company may have a limited life under state law and it may be deemed terminated when a member leaves the company for whatever reason. The S Corporation will continue even after a shareholder leaves the corporation. A general partnership exposes the partners to unlimited personal liability. An S Corporation allows for shareholder asset protection. Distributions to shareholders of an S Corporation are taxed at the individual level whereas a C Corporation may have a lower tax rate.
Given the above, the facts and circumstances of your individual situation will dictate whether an S Corporation makes sense for your equine business. In a large number of cases the S Corporation allows for asset protection, tax planning and reduction of taxes paid on any level. For those reasons, the S Corporation may serve as the entity of choice.
For further questions regarding the selection of an entity for use in an equine activity feel free to contact our offices at info@cataneselaw.com or (818) 707-0407.