In the world of big business corporate earnings are taxed twice under the Internal Revenue Code. The first layer of taxation occurs with the traditional corporate income tax. The second tier of taxation happens when dividends are issued to shareholders. The shareholder pays an income tax at their personal rate.
The K-1 is an Internal Revenue Service tax document allocating the respective net income and/or losses to the respective owners. It is provided to the owners upon completion of the annual tax return. Each line on the K-1 identifies to the owner how much to include in the respective sections of their personal tax returns from the business operations.
The average person may not realize this, but the most notable joint venture in existence today is the National Football League. It figuratively owns every Sunday in the fall of each year. It is an association of 32 clubs agreeing to compete with each other, i.e. engage in athletic entertainment. Each venturer is its own business entity; the league generates its own revenue stream (mostly TV rights) and shares these profits with its members equally.
One of the tax attributes of an S-Corporation over other forms of tax entities is the ability to reduce the overall tax obligation. Naturally the lower the overall tax requirement the more profit generated for the owner(s). The S-Corporation allows an owner to reduce their tax responsibility via the compensation package assigned to the owner.
There is multi-step process to establish a Limited Liability Company (LLC). You must first be recognized by the state of origin and then apply to the Internal Revenue Service to identify the particular tax entity arrangement. Both recognition processes have several steps involved. This article guides the entrepreneur through each of the steps to create a Limited Liability Company.
Real Estate Investment Trusts are corporations, trusts or associations that act as agencies in real estate and associated mortgages. This is a specialized tax segment and it requires recognition by the Internal Revenue Service to operate as a Real Estate Investment Trust (REIT). In general, the REIT pays little to no income taxes and acts very similar to a pass-through entity for tax purposes. All REITs must comply with Code Section 856 which addresses compliance for this privileged tax advantage. Typically, REITs file Form 1120-REIT for tax purposes.
A secondary advantage for REIT status is the ability to raise capital via syndication. Section 856(a) and (b) require a minimum of 100 shareholders or owners of interest in the business entity. This allows for a more advantageous management situation by having a more formal elected board of trustees or directors. In addition, it allows for greater ease of transfer of ownership with the respective investors.
To fully appreciate the Real Estate Investment Trust, you should become acquainted with the history behind REITs. From there, there are unique advantages associated with REITs and an investment in one. As with all business situations, there are some disadvantages and you should be aware of them. The following sections cover these three topics and I’ll finish off with my own conclusion.
Code Section 465 of the Internal Revenue Code defines ‘At-Risk’ as the financial value the taxpayer has in jeopardy related to the business activity the taxpayer is invested in as some form of an owner. Effectively, the taxpayer may only take losses on his tax return contingent on the loss being directly tied to invested dollars with some form of tax basis.
Those small businesses using partnership or S-Corporation formats issue Form K-1 to the respective owners. When income is assigned to the owner and there is no corresponding cash related to that income, then this income is referred to as ‘Phantom Income’. In effect, it is assigned income for tax purposes without the corresponding cash to pay the tax liability.