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.