Home | General | Maximizing the financial benefits of your franchise

Maximizing the financial benefits of your franchise

Choice of business entity (partnership, LLC, or S or C corporation) and minimizing your tax obligations can increase your net worth even with a stagnant franchise.

If you own a franchise and do your own accounting and taxes, please read this article. Here is a sample:

Paying the IRS—On Your Personal Income and Dividends

What makes S corporation dividends so attractive? Not only is there no corporate income tax, but the S corporation can cut other taxes as well. By paying the owner and select employee/shareholders with dividends, in addition to salary, the amount of income subject to Social Security, Medicare, and self-employment tax (and employer matches) can be reduced. Paying revenue as dividends removes that income from the Social Security/Medicare tax “pot” (7.65 percent employee/7.65 percent employer). The recipients pay personal tax on the payouts, but at the dividend rate, rather than the ordinary income rate.

Bigger Caveat: The Internal Revenue Service has been looking into S corporations and comparable business entities for possible abuses—including using S corporation dividends to avoid income tax. Under IRS rules, owners (and any other beneficiaries) of S corporation dividends must first receive a reasonable salary before revenue is paid as dividends. The IRS announced plans for a major audit of S corporations last summer, so it is an excellent idea to consult a tax professional and discuss this strategy at your annual corporate board of directors meeting. Dividends are a return on investment, not a substitute for a salary or a tax avoidance technique.

Does a Change Make Sense for a Going Concern?

Thinking of changing from a C corporation to an S corporation or LLC? Or maybe changing from an S corporation or LLC back to a C corporation? Or maybe you want to change between an LLC and an S Corporation? Consider this:

According to Pam Feely, a Lakewood (Col.)-based CPA, “For a sole shareholder the S corporation is an excellent entity choice. As long as the shareholder takes a reasonable salary, some of the business earnings can be taken as dividend distributions.” These dividends are only taxed once, at ordinary income tax rates (unlike the double taxation for C corporation dividends) and there is no self-employment, Social Security, or Medicare tax owed. The S corporation is also a good choice when there are several shareholders and all are actively working in the business, she says.

“In my experience, LLCs are appropriate when there is a disparity between ownership and sweat equity,” Feely explains. “Earnings in an LLC can be distributed out-of-proportion to ownership; this cannot happen in an S corporation.”

Talk with your lawyer and/or accountant on perhaps reorganizing your franchised business. The same goes for selling or buying a business – the legal structure matters a great deal, and getting your “price” so you can reach your “goals” may be a matter of the right combination of legal and financial structuring.

From a legal and tax standpoint – wealth generation (accrue net worth while paying or deferring taxes as much as possible, possibly self-insurance through a captive insurance program), wealth preservation (protecting your assets from law suits), and wealth transfer to your children (transferring non-voting interests in business entities to your children’s entities or trusts on a discounted basis; leveraging the child’s lower tax bracket; etc) are all strategies that nearly anyone can implement now and make the most of what you have. See your tax and estate lawyer for details.

About Ryan Knoll

Attorney and advisor with an interest in franchising. Feel free to email me comments and questions on the "Contact Us" page.
Home | Maximizing the financial benefits of your franchise

Maximizing the financial benefits of your franchise

Choice of business entity (partnership, LLC, or S or C corporation) and minimizing your tax obligations can increase your net worth even with a stagnant franchise.

If you own a franchise and do your own accounting and taxes, please read this article.   Here is a sample:

Paying the IRS—On Your Personal Income and Dividends

What makes S corporation dividends so attractive? Not only is there no corporate income tax, but the S corporation can cut other taxes as well. By paying the owner and select employee/shareholders with dividends, in addition to salary, the amount of income subject to Social Security, Medicare, and self-employment tax (and employer matches) can be reduced. Paying revenue as dividends removes that income from the Social Security/Medicare tax “pot” (7.65 percent employee/7.65 percent employer). The recipients pay personal tax on the payouts, but at the dividend rate, rather than the ordinary income rate.

Bigger Caveat: The Internal Revenue Service has been looking into S corporations and comparable business entities for possible abuses—including using S corporation dividends to avoid income tax. Under IRS rules, owners (and any other beneficiaries) of S corporation dividends must first receive a reasonable salary before revenue is paid as dividends. The IRS announced plans for a major audit of S corporations last summer, so it is an excellent idea to consult a tax professional and discuss this strategy at your annual corporate board of directors meeting. Dividends are a return on investment, not a substitute for a salary or a tax avoidance technique.

Does a Change Make Sense for a Going Concern?

Thinking of changing from a C corporation to an S corporation or LLC? Or maybe changing from an S corporation or LLC back to a C corporation? Or maybe you want to change between an LLC and an S Corporation? Consider this:

According to Pam Feely, a Lakewood (Col.)-based CPA, “For a sole shareholder the S corporation is an excellent entity choice. As long as the shareholder takes a reasonable salary, some of the business earnings can be taken as dividend distributions.” These dividends are only taxed once, at ordinary income tax rates (unlike the double taxation for C corporation dividends) and there is no self-employment, Social Security, or Medicare tax owed. The S corporation is also a good choice when there are several shareholders and all are actively working in the business, she says.

“In my experience, LLCs are appropriate when there is a disparity between ownership and sweat equity,” Feely explains. “Earnings in an LLC can be distributed out-of-proportion to ownership; this cannot happen in an S corporation.”

Talk with your lawyer and/or accountant on perhaps reorganizing your franchised business.  The same goes for selling or buying a business – the legal structure matters a great deal, and getting your “price” so you can reach your “goals” may be a matter of the right combination of legal and financial structuring.

From a legal and tax standpoint – wealth generation (accrue net worth while paying or deferring taxes as much as possible, possibly self-insurance through a captive insurance program), wealth preservation (protecting your assets from law suits), and wealth transfer to your children (transferring non-voting interests in business entities to your children’s entities or trusts on a discounted basis; leveraging the child’s lower tax bracket; etc) are all strategies that nearly anyone can implement now and make the most of what you have.  See your tax and estate lawyer for details.

About Ryan Knoll

Attorney and advisor with an interest in franchising. Feel free to email me comments and questions on the "Contact Us" page.

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