Starting a business.

Facts: Barney Dino is tired of his job at Anonymous Corp. and has sufficient funds available to pursue his dream of opening a restaurant, Barney's Grotto and Clam Bar. He plans to consult with his tax adviser about business start-up issues, including choice of entity, capitalization and expenses. Issue: What are the tax considerations in Barney's proposed business venture?

Analysis

The following checklist can be used to focus on the important issues confronting a client considering starting a business.

Client:

Procedures                        "[check]" or N/A   Initials   Date

1. Establish a profile of the
client's start-up business,
focusing on the nature of the
client's business operations
and goals clarification.

2. Evaluate the liability
exposure inherent in the business
and identify ways to minimize
this liability through entity
selection.

3. Review the problem of double
taxation and identify ways to
eliminate or mitigate the problem.

4. Consider the advantages of C
corporation status, focusing on
the interplay of the C corporation
issues of double taxation and the
favorable tax rates that apply
to relatively low levels of C
corporation taxable income.

5. Evaluate the advantages and
disadvantages of S corporation
status, focusing on the relatively
inflexible rules on the number of
shareholders, types of permitted
shareholders and the
one-class-of-stock rule.

6. Review the advantages and
disadvantages of partnerships,
focusing on the flexibility to
tailor ownership interests with
varying rights to cashflow,
liquidation proceeds and tax
benefits.

7. Consider the tax and nontax
advantages and disadvantages
of limited liability company
(LLC) status, focusing on the
lack of legal certainty regarding
the extent of liability protection
offered by LLCs.

8. Evaluate the advantages and
disadvantages of limited
liability partnership (LLP)
status for professional practice
businesses, focusing on whether
the practice can operate as
an LLC rather than as an LLP.
LLC status is generally
preferable if it is available.

9. Consider the advantages and
disadvantages of sole
proprietorship status for the
business, focusing on whether
liability can be adequately
limited via insurance and other
measures, rather than using a
corporation, LLC or LLP to
operate the business.

10. If incorporating tax-free,
ensure that the shareholder does
not receive debt securities in
exchange for property transferred
to the corporation in a Sec. 351
transfer. Debt securities are now
classified as boot received.

11. If liabilities exceed tax
basis of property transferred to
an entity, consider ways to prevent
owners from recognizing gain on the
transfer.

12. If the shareholder has a net
operating loss (NOL) or capital loss
carryforward, consider having the
shareholder sell any appreciated
assets to the corporation rather
than contributing them in a tax-free
incorporation. In a taxable
incorporation, the shareholder is
allowed to offset the NOL or
capital loss carryforward against
gain recognized on the taxable
formation. The corporation obtains
a basis step-up for the appreciated
assets.

13. Consider using owner debt in
combination with owner stock equity
to capitalize a newly formed C
corporation. Owner debt provides a
way to bail out corporate profits
and reduces the problem of double
taxation.

14. If owner debt is being used to
fund a C corporation, consider ways
to ensure that it is not reclassified
as owner equity.

15. Evaluate the need to comply
with the straight-debt safe harbor
if there is S owner debt.

16. Attempt to qualify any stock
issued by a C corporation or an S
corporation as Sec. 1244 stock.
Shareholders with Sec. 1244 stock
are allowed ordinary loss treatment
on the sale or worthlessness of
that stock.

17. If Sec. 1244 stock is issued,
ensure the company maintains a
worksheet in its files that records
all appropriate information
related to the stock issuance.

18. Consider the many tax pitfalls
to avoid in dealing with Sec.
1244 stock.

19. Determine whether it makes
sense to qualify the company's stock
as Sec. 1202 qualified small business
stock. Shareholders are allowed to
exclude 50% of the gain from the
sale or exchange of qualified small
business stock.

20. Consider the need for front-end
tax planning for partners or S
shareholders. Establish a system for
tracking adjustments to an owner's
tax basis. Also, identify ways to
maximize cashflow distributions
to owners with minimal tax
consequences.

21. If a client is considering
self-employment (SE), advise him
of the tax advantages and
disadvantages. Also, make him
aware of the many tax and nontax
issues involved in the switch from
employee to sole proprietor.

22. Consider whether the client's
choice of entity creates
opportunities to minimize FICA
or SE tax (or both).

23. Structure related-party
transactions to minimize FICA
and SE tax.

24. Determine whether the activity
is possibly subject to the hobby
loss limitations.

25. If it appears the hobby loss
rules may apply, advise the client
of steps that can help avoid them.

26. Identify investigation and
start-up costs. Distinguish them
from organizational expenditures.

27. Note the special planning
considerations for handling
start-up costs. Ensure that the
costs are amortized over not less
than 60 months beginning with the
month in which the business begins.
Albert B. Ellentuck, Esq.
Of Counsel
King and Nordlinger, L.L.P.
Washington, D.C.

Editor's note: This case study has been Adapted from "Guide to Tax Planning for Individuals," 3rd Edition, by Anthony J. DeChellis, Douglas L. Weinbrenner, Catherine A. Roeder and James F. Reeves, Published by practitioners Publishing Company, Fort Worth, Tex. 1998.3