1. 1 CHOICE OF ENTITY TAX CONSIDERATIONS Thomas F. Schnellenberger September 20, 2006 1607621

2. 2 OVERVIEW Sole ProprietorshipSole Proprietorship Single Member Limited Liability Company (“SMLLC”)Single Member Limited Liability Company (“SMLLC”) General PartnershipGeneral Partnership Limited PartnershipLimited Partnership Limited Liability Company (“LLC”)Limited Liability Company (“LLC”) S CorporationS Corporation C CorporationC Corporation Ms. Big Bucks is contemplating how to organize her new business:

3. 3 OVERVIEW Ms. Big Bucks uses $10 of personal funds and $50 of funds borrowed from bankMs. Big Bucks uses $10 of personal funds and $50 of funds borrowed from bank Year 1 losses = $50 (Ms. Big Bucks’ share)Year 1 losses = $50 (Ms. Big Bucks’ share) Year 2 profits = $100 (Ms. Big Bucks’ share)Year 2 profits = $100 (Ms. Big Bucks’ share) Business is sold at the end of year 2 for $1,000Business is sold at the end of year 2 for $1,000 Ms. Big Bucks is active in the businessMs. Big Bucks is active in the business Assume the following:

4. 4 CHOICE OF ENTITY SOLE PROPRIETORSHIP

5. 5 FORMATION Business bank accountBusiness bank account Federal and state Employer Identification Numbers (“EINs”) and other tax registrationsFederal and state Employer Identification Numbers (“EINs”) and other tax registrations LicensesLicenses No liability protectionNo liability protection Self employment (“SE”) taxSelf employment (“SE”) tax Ms. Big Bucks Bank $50 Note CHOICE OF ENTITY SOLE PROPRIETORSHIP

6. 6 Employment Tax Components and Rates Self-Employed Employer Employee Individual OASDI - Imposed on Earnings up to $94,200 (2006): Employer 6.2% 6.2% Employee __ 6.2% 6.2% Total OASDI 6.2% 6.2% 12.4% Medicare: Employer (1) 1.45% 1.45% Employee ___ 1.45% 1.45% Total Medicare 1.45% 1.45% 2.9% Total 7.65% (1) 7.65% 15.3% (2) (1) Deductible by employer in arriving at employer’s taxable income. (2) One-half deductible in arriving at adjusted gross income.

7. 7 FIRST YEAR Unless otherwise noted, it has been assumed that: (1) at-risk and passive loss rules are satisfied, and (2) Ms. Big Bucks has other sources of SE income against which loss can be offset. After-tax benefit of $24.72 SOLE PROPRIETORSHIP Self-employment TaxIncome Tax Cash Income from Operations ($50.00) ($50.00)* Self-employment Inclusion Percentx 92.35% Self-employment loss(46.18) Self-employment Tax Rate x 15.3% Self-employment Tax benefit (7.06) 3.53 Net Taxable Income (46.47) Assumed Effective Rate x 38% Tax Cost ($7.06) ($17.66) 24.72 Net Cash $ 24.72

8. 8 SECOND YEAR * After-tax cost of $49.45 SOLE PROPRIETORSHIP Self-employment TaxIncome Tax Cash Income from Operations $100.00$100.00 Self-employment Inclusion Percent x 92.35% Self-employment Income 92.35 Self-employment Rate x 15.3% Self-employment Tax 14.13 (7.06)* Net Taxable Income 92.94 Assumed Effective Income Tax Rate x 38% Tax Cost $14.13$35.32 (49.45) ($49.45)

9. 9 SALE OF BUSINESS SOLE PROPRIETORSHIP Income Tax Cash Sales price $1,000.00 $1,000.00 Basis Personal funds$ 10 Borrowed funds 50 Year 1 loss (50) Year 2 profit 100 (110.00) Gain 890.00 Estimated capital gains rate 17% Income tax$ 151.30 (151.30) Loan repayment (50.00) Net sales proceeds$ 798.70

10. 10 NET CASH SOLE PROPRIETORSHIP Original investment($10.00) First year tax 24.72 Second year tax (49.45) Sale proceeds 798.70 Total$763.97

11. 11 CHOICE OF ENTITY SINGLE MEMBER LLC

12. 12 FORMATION Absent an affirmative election to be treated as a corporation, Big Bucks LLC will be disregarded for income tax purposes; i.e., treated as a sole proprietorship Bank account EINs Licenses Liability Protection SE tax SINGLE MEMBER LLC Ms. Big Bucks $10 100% Ownership Big Bucks LLC Bank Note $50

13. 13 NET CASH SINGLE MEMBER LLC Original investment($10.00) First year tax 24.72 Second year tax (49.45) Sale proceeds 798.70 Total$763.97

14. 14 CHOICE OF ENTITY GENERAL PARTNERSHIP

15. 15 FORMATION GENERAL PARTNERSHIP Ms. Big Bucks 50% General Partnership Interest 50% General Partnership Interest Mr. Big Bucks Big Bucks, General Partnership $10 Bank $100

16. 16 NET CASH GENERAL PARTNERSHIP Original investment($10.00) First year tax 24.72 Second year tax (49.45) Sale proceeds 798.70 Total$763.97

17. 17 CHOICE OF ENTITY LIMITED PARTNERSHIP

18. 18 FORMATION EINs Bank account Liability protection for limited partner only Deductibility of losses subject to basis, at-risk and passive loss limitations General partner subject to self-employment tax but limited partner is generally not Note Ms. Big Bucks 50% General Partnership Interest 50% Limited Partnership Interest Mr. Big Bucks Big Bucks, L.P. $10 Bank $100 CHOICE OF ENTITY LIMITED PARTNERSHIP

19. 19 FIRST YEAR Ms. Big Bucks Mr. Big Bucks Big Bucks, L.P. Taxable Loss (1) Taxable Loss (1) Basis limitation results in loss limitation to Mr. Big Bucks. LIMITED PARTNERSHIP

20. 20 FIRST YEAR MS. BIG BUCKS LIMITED PARTNERSHIP Self-employment TaxIncome Tax Cash Income from Operations ($90.00)($90.00) Self-employment Inclusion Percentx 92.35% Self-employment Loss ($83.12) Self-employment Tax Rate x 15.3% Self-employment Tax Benefit ($12.72) (6.36) Net Taxable Income ($83.64) Assumed Effective Income Tax Rate x 38% Tax Cost/(Savings) ($12.72) ($31.78) 44.50 Net Individual Cash $ 44.50 After-tax savings of $44.50

21. 21 FIRST YEAR MR. BIG BUCKS LIMITED PARTNERSHIP Self-employment TaxIncome Tax Cash Income from Operations$0.00($10.00) $0.00 Self-employment Inclusion Percentx 92.35% Self-employment Income $0.00 Self-employment Tax Rate x 15.3% Self-employment Tax Cost $0.00 0.00 Net Taxable Income ($10.00) Passive Loss Limitation 10.00 Net Taxable Income (0.00) Assumed Effective Rate x 38% Tax Cost $0 $ 0 0 Net Individual Cash $ 0 No after-tax savings because of basis limitation

22. 22 First Year Note Ms. Big Bucks GP Mr. Big Bucks LP Big Bucks, L.P. Bank $100 LIMITED PARTNERSHIP LP’s basis limitation can be avoided if LP guarantees at least $10 of bank debt Guarantee $90 loss $10 loss

23. 23 SECOND YEAR MS. BIG BUCKS LIMITED PARTNERSHIP Self-employment TaxIncome Tax Cash Income from Operations $ 140.00 $ 140.00 Self-employment Inclusion Percent x 92.35% Self-employment Income $ 129.54 Self-employment Tax Rate x 15.3% Self-employment Tax Cost $ 19.82 Net Taxable Income $ 130.09 Assumed Effective Income Tax Rate x 38% Tax Cost $ 19.82 $ 49.43 Net Individual Cash After-tax cost of $69.25

24. 24 SECOND YEAR MR. BIG BUCKS LIMITED PARTNERSHIP Self-employment Tax Tax Cash Income from Operations$ 0 $ 60.00 Passive Loss Carryover Net Taxable Income $ 50.00 Assumed Effective Rate x 38% Tax Cost $0 $ 19.00 Net Individual Cash After-tax cost of $19.00 (reduced because of carryover) No self-employment tax because of LP status

25. 25 SALE OF BUSINESS LIMITED PARTNERSHIP Income Tax Cash Sales price $ 1,000$1,000 Basis Personal funds $ 20 Borrowed funds 100 Year 1 loss Year 2 profit 200 220 Allocable share x 50% Gain $ 890.00 Assumed capital gains rate 17% Income tax $ 151.30 Repay bank (Allocable Share) Net sales proceeds$ 798.70

26. 26 NET CASH LIMITED PARTNERSHIP Ms. Big BucksMr. Big Bucks Original Investment First Year Tax 44.50 -0- Second Year Tax Sale Proceeds 798.70798.70 Total $ 763.95 $ 769.70

27. 27 CHOICE OF ENTITY LIMITED LIABILITY COMPANY (LLC)

28. 28 CHOICE OF ENTITY Limited Liability Company Similar to limited partnership, but with limited liability for all.

29. 29 SELF EMPLOYMENT TAX CHOICE OF ENTITY Treasury issued Proposed Regulations in 1997 which would exclude limited partners and LLC members from self- employment tax unless individual has any one of the following: (1)personal liability for debts or claims against the entity by reason of being owner, (2)authority to contract on behalf of the entity, or (3)participates in the entity’s business for more than 500 hours during the tax year.

30. 30 CHOICE OF ENTITY S CORPORATION

31. 31 FORMATION Bank accountBank account EINsEINs S corporation election requiredS corporation election required LicensesLicenses Liability ProtectionLiability Protection CHOICE OF ENTITY S CORPORATION Ms. Big Bucks S Corporation $50 Note Bank 100% Stock Cash $10

32. 32 FIRST YEAR S CORPORATION *Deductibility of loss subject to at-risk, basis limitation and passive loss rates. Assume individual is active in business. Salary???? Income TaxCash Income from Operations $0 Basis Limitation 40 Net Taxable Income Assumed Effective Rate x 38% Tax Cost 3.80 Net Cash$3.80

33. 33 FORMATION CHOICE OF ENTITY S CORPORATION Ms. Big Bucks S Corporation $50 Note Bank 100% Stock Cash $60 Avoiding Basis Limitation Note: Guarantee by Ms. Big Bucks will not create basis

34. 34 SECOND YEAR S CORPORATION TaxCash Income from Operations $100 $0 Suspended Loss Deductible Net Taxable Income $ 60 Assumed Effective Rate x 38% Tax Cost $22.80 Net Cash

35. 35 SALE OF BUSINESS S CORPORATION Income Tax Cash Sales Price $ 1,000 $ 1,000 BasisPersonal funds$10 Loaned funds 50 Year 1 loss Year 2 profit 100 Gain $ 890 Assumed Capital Gains Rate x 17% Income Tax $ 151.30 Repay Bank Loan Net Cash$ 798.70

36. 36 NET CASH S CORPORATION Original Investment First Year Tax 3.80 Second Year Tax Sale 798.70 Total $769.70

37. 37 WHY NOT AN S CORP? Only natural persons and certain trusts can be shareholdersOnly natural persons and certain trusts can be shareholders Maximum 100 shareholders (family members may be treated as one shareholder)Maximum 100 shareholders (family members may be treated as one shareholder) Only one class of stock permitted (except can have differing voting rights)Only one class of stock permitted (except can have differing voting rights) No special allocationsNo special allocations No tax basis for liabilities even if guaranteeNo tax basis for liabilities even if guarantee A distribution of appreciated assets from an S corporation is a taxable event; such a distribution from a partnership or LLC generally is tax-freeA distribution of appreciated assets from an S corporation is a taxable event; such a distribution from a partnership or LLC generally is tax-free Salary/payroll taxesSalary/payroll taxes CHOICE OF ENTITY S CORPORATION vs. PARTNERSHIP

38. 38 CHOICE OF ENTITY C CORPORATION

39. 39 FORMATION Bank accountBank account EINsEINs LicensesLicenses Liability ProtectionLiability Protection CHOICE OF ENTITY C CORPORATION Ms. Big Bucks C Corporation $50 Cash Note Bank 100% Stock Cash $10

40. 40 FIRST YEAR CHOICE OF ENTITY C CORPORATION Income from Operations Net Operating Loss Carryover

41. 41 SECOND YEAR CHOICE OF ENTITY C CORPORATION Income from Operations $ 100 Net Operating Loss Carryover Used Net Taxable Income $ 50 Assumed Effective Rate x 18% Net Cash Cost to Corporation $ 9

42. 42 SALE OF ASSETS C CORPORATION CorporateCorporateIndividualIndividual Income TaxCashIncome TaxCash Sales Price $1,000 $1,000 Basis Original Investment$10 Bank Loan 50 Net Cash Investment 41 from Operations Net Gain 899 Assumed Corporate Rate x 40% Corporate Tax$ 359.60 Repay Bank Loan Net Cash to Distribute $ 590.40 $ 590.40$ 590.40 Individual Basis Net Gain 580.40 Assumed Capital Gains Rate x 17% Tax 98.67 (98.67) Net Cash $491.73

43. 43 SALE OF STOCK C CORPORATION Income Tax Cash Sales Price $ 950* $ 950 Basis 10 Net Gain $ 940 Assumed Capital Gains Rate x 17% Tax $ 159.80 Net Cash $ 790.20 *Assume stock sold for $1,000 less $50 bank loan.

44. 44 NET CASH C CORPORATION Sale Sale of of AssetsStock Original Investment First Year - 0 - - 0 - Second Year - 0 - - 0 - Sale $ 491.73$ 790.20 Net Cash $ 481.73 $ 780.20

45. 45 COMPARISON OF NET CASH CHOICE OF ENTITY Sole Proprietorship/General Partner$763.97 Limited Partner 769.70 S Corporation 769.70 C Corporation – Sale of Assets 481.73 C Corporation – Sale of Stock 780.20

46. 46 C CORPORATION DOUBLE TAX ON DIVIDENDS CHOICE OF ENTITY TaxCash Corporate Profit$100$100 Assumed Effective Corporate Tax Ratex 40% Income Tax$ 40 Cash Available for Distribution$ 60$ 60 Assumed Effective Individual Tax Ratex 17% Income Tax$10.20 Net Cash$49.80

47. 47 EMPLOYEE FRINGE BENEFITS CHOICE OF ENTITY Group term life insurance Disability insurance §125/cafeteria plans Educational expenses Employee-paid parking Health and accident plans Meals and lodging furnished for the convenience of the employer Sole proprietors, partners (including LLC members) and more than 2% shareholders in an S corporation are not eligible for the following tax free benefits:

48. 48 EMPLOYEE FRINGE BENEFITS CHOICE OF ENTITY 2000 60% 2001/2002 70% 2003100% 2004100% 2005100% 2006100% To ameliorate adverse tax consequences to self-employed, a percent of health/medical insurance costs and actual costs are deductible in arriving at Adjusted Gross Income:

49. 49 Choice of Entity Multi-State Operations Each owner must file in multiple jurisdictions Entities may be treated differently from state to state Non-residents may be subject to withholding on income Operations in more than one state complicate flow through entity (partnership (for tax) or S corporation) operation because:

50. 50 Choice of Entity Observations Sole Proprietorship – simplest, but no liability protection. Single Member LLC – liability protection. General Partnership – no liability protection. Limited Partnership – liability protection and no self-employment tax for L.P.s. LLC – liability protection for all and flexible, but self-employment tax question. S Corporation – liability protection for all, but not as flexible. Can manage FICA (self-employment tax). C Corporation – liability protection for all, but double taxation not attractive.