 Hello and welcome to this session. This is Professor Farhad and this session we're going to be looking at the tax treatment of various business forms. These topics that we're going to be discussing today will be covered in an income tax course, the CPA exam regulation section, as well as the enrolled agent exam. As always, I would like to remind you, my viewers, to connect with me on a professional level. So if you do have a LinkedIn account, please connect with me. If you don't have a LinkedIn account, I strongly suggest you do create one. I do have a Facebook page. So if you like my Facebook page and you are welcome to connect with me on a personal level, you want to make sure you subscribe to my YouTube. This is where I house all my lectures and I have over 1500 lectures, including accounting, tax on auditing. I have a LinkedIn account, as well as Twitter and a website where I house all my courses organized by chapter. In this session, we're going to be looking at the various business forms. So this is basically an introduction. This session is an introduction to many other business forms. So I'm going to be mentioning S Corporation today, Partnerships C Corporation, and I'm going to be saying we're going to see those topics much, much more in details later on. Because when you operate a business, you can operate a business under different forms. You could run your business as a sole proprietorship. You could run it as a partnership. If you have an estate or trust or estate, you have you could have an S Corporation also called sub chapter S Corporation. You could have a regular corporation, which is the regular corporation is CC as in Charlie Corporation, or you can form LLC limited liability companies. Now we're going to be covering sole proprietorship, partnership, S corp, regular corp and limited liability very briefly today. And what I mean briefly is just give you a taste of them. We don't cover trust on estate. That's going to be its own chapter later on. But eventually, each one of those partnership we're going to have maybe two chapters, which is we'll have a lot of recordings as corporations. Same thing, we might have 15 different lectures, C corp, we might have 20 different lectures on those, but now this is just giving you a taste of it. So it's very important that you understand those concepts before you dive into the corporation chapter, before you dive into the partnership chapter. And also in this session, we will compute the taxes, what happened if you earned income and you are running running your business as a sole proprietorship versus a corporation. So starting with a sole proprietorship, what is a sole proprietorship? So means one, one person is operating the business. Here you don't have to have any formal paperwork done. For example, I have a sole proprietorship, my YouTube channel is a sole proprietorship. It's a not separate taxable entity. This is important. This is important. So let's make sure we understand this concept because it's going to appear and again and again. So when I compute my revenues and expenses, when I take my revenues and my expenses, I compute them on schedule C, which I will show you in a moment. So I'll have my revenues minus expenses or deduction, whatever you want to call them. Then I will get to net income. Okay, so guess what? This net income goes to my 1040. So this is my income. So the business, which is I'm going to call here YouTube, my YouTube business, which is what you are viewing now, and my income are the same. My YouTube from income goes to me, goes to my 1040, and I have to pay taxes on that income as an individual, as an individual person, I have to pay taxes on that money. Okay, so income and expenses of the proprietorship retain their character when reported by the proprietary. So whatever income I have on my C, it retain its character when it comes to me. The new thing about sole proprietorship this year, we are going in starting this year till 2025, we're going to have the 20% qualified business income deduction, and this is going to be available to 2025. So from 2018 to 2025, we're going to have an additional 20% qualified business income deduction. Now, if you don't know what this is, I have two recordings over an hour and a half. So go ahead and check out the 20% qualified business income deduction. Let's take a look at schedule C. Basically, it looks like a great degree looks like an income statement. I'm just going to point out a few things. First, you have your income. So you report the income from the business, then you deduct your expenses from the business. And as a result, you have either a net profit or a net loss. And just give you an example 100,000 in total income, 40,000 in total expenses, I'm just making these numbers up. So your profit is 60,000. Then you're going to have another deduction. Now, here's what I want, the 20% deduction. You'll have also the 20% deduction on your 1040. But here's what I want you to see. If you examine all the expenses and if you want to, you can examine them. There is no taxes. So on schedule C, I don't pay any taxes on the 60,000. So there is no taxes on the 60,000. I don't pay any taxes. In other words, I made 20,000, 60,000 that money not taxable yet. We did not pay taxes on it. Therefore, it goes to me. And this is important. This is important concept because this business, my YouTube business is not a separate entity. My YouTube business is my income personally. Let's take a look at the second type of business, which is a partnership business. Partnership business. Think of a partnership business, just like a sole proprietorship, but multiple, multiple sole proprietorship. It's a separate entity, but does not pay tax. So from a tax perspective, all the income goes to the owners, just what I showed you earlier. Now, there is a form. They do fill out. They don't fill out schedule C. They fill out a form called 1065, which will see shortly. And it's called an information return. And in what is in practice, I used to be very familiar with that form. I mean, I have to admit that I'm still familiar with it, but it was, I used to have dreams about 1065 and 1020s and 1020s, but that's beside the point. So you do fill out, you do send your income and your expenses and your deduction to the IRS. That's only for information purposes. You don't pay any taxes on the partnership itself. Okay. Now business income and expenses are aggregated in computing, ordinary business income or loss. So just revenues minus expenses. Now, here's what you need to know about partnership. Certain income and expenses items are reported separately to the partners. What are those separate items? Now, I'm going to list them and I'm not going to explain why and what are the consequences. I'm going to give you a feeling like basically a sense of it, but we're going to have one whole chapter, not whole chapter about separately stated item, but they will be covered when we cover the partnership. So basically separately stated items such as interest and dividend income, long-term capital gain, charitable contribution and investment expenses. And those to be discussed much, much, much more in details later, those will be separately reported. So what's going to happen? I'll show you the form in a moment. So you're going to have revenues and expenses and you're going to have certain items. So if the partnership have dividend income, dividend income flows to the owner. If they have any interest, interest flows to the owner. If they have any long-term capital gain, it flows to the owner. It's not part of the 1065. Okay. So partnership, ordinary income or loss and separately reported items are allocated to the partners according to their profit or share, profit and loss sharing ratio. So whatever if the business made a profit or the business incurred a loss and you qualify to get 20%, you're going to get 20%. Also if they have separately stated items such as interest, dividend income, long-term capital gain, those are also allocated to you separately and they're allocated through a form called K1. Again, if you prepare taxes and you'll be very familiar with that term, with that form, K1. So K1 reports partner share of partnership, ordinary business income and loss and separately stated item. So on the K1, they will tell you how much ordinary business income you have from the business and what's your share of separately stated item. Actually, I'm just thinking right now, I'm not going to show you the K1 because I did not include it in this recording, but I could assure you when we cover the partnership chapter, I will show you a K1. So now I'm going to show you the 1065. Each partner reports those items on his or her own return separately. And this is what a 1065 looks like. Pretty much like an income statement. You have a section where you report all the income, then you have a section where you report the deductions, which are the expenses. Then revenues, income minus deduction gives you the profit. Then what's going to happen to that profit? It's just also just work, just work up some numbers real quick. So you have total income all in all 100,000 and total deduction all in all on ordinary business deduction, total deduction. Let's make it 40,000. So ordinary business income loss is 60,000. What's going to happen is this, what's going to happen is this, this 60,000. Let's assume we have four simplicity. Let's keep it simple. We have two partners and each partner has 50% sharing and profit and loss. So of that 60,000, 30,000 go to partner A and 30,000 go to partner B. And partner A and partner B pay taxes on that profit. Partner A and partner B pay taxes depending on their individual income tax rate. So notice if you examine those deductions, if you examine the deductions here, there is no taxes. So the partnership doesn't pay any taxes on the profit. There's no place where you pay, okay, here's your taxes, pay taxes on that profit. You don't. The profit goes to the owner and the owner pay taxes on that profit. It's a pass through entity. Just like assault proprietorship, the income goes from the owner. The income goes, I'm sorry, the income goes from the business to the owner. Same thing with a partnership. Now, I just, I don't want to simplify this, but I have to simplify this. There are many types of partnership. There's a general partnership, limited partnership, LLC, so on and so forth. Just we're talking about partnership in general here. The next thing we're going to look at is you could operate your business using an escort. An escort is a separate entity, but only pay taxes on the built in gain. Don't worry about the built in gains. Now we'll talk about this later. So here's what I'm going to tell you from a tax perspective, although it's named a corporation from a tax perspective, the escort operation is like a partnership. What assault proprietorship? What does that mean? It means the, the profit from the business goes to the owners and the owner space taxes. So simply put, sole proprietorship, a partnership and escort operation, the three forms of business. The profit goes to the owner. The owner pays the, the profit goes to the owner and the owner pay taxes on that profit. Okay. Although partnership and escort operation are separate entity, the taxes is not the taxes goes to the owner. Okay. S corporation defy the form called 1120 s. And again, when I was in practice, I, you know, during the tax season, we would prepare many of those. Okay. Similar to partnership taxation, ordinary income or loss flows to the shareholders to be reported on their separate return. And we also have a certain item flows through the shareholder and return their separate character, which, which are called separately stated items, like long-term capital gains, shareable contribution, anything that go through the escort operation, they are reported separately. Now you might be saying again, why you will see why later on just, I don't want to kind of, you know, explain this because it takes time to explain it. So the escort operation, I'll explain it later, but not in this session, the escort operation, ordinary business income or loss and the separately reported items. Again, we're going to be talking about those much, much more in details are allocated to the shareholder, according to their stock ownership interests. Okay. That's all what it is. And we prepare if we, we, we prepare something called we prepare the income in deductions on 1120 s. Notice the word s s for S corporation. So report the income. Again, $100,000 of income. I don't know $40,000 of deductions and $60,000 of profit. And let's assume we have two owners. Again, let's keep it simple. We have a 50% one person owns 50% of the company and the other owns 50%. What's going to happen? $30,000 goes to a to owner a notes. I'm using the word owner because it's kind of a corporation and $30,000 goes to owner B and they pay taxes. A and B pay taxes, pay taxes on that profit, pay taxes on that profit. Notice if you examine all the lines here, there's no taxes. So the business don't pay taxes, who pays taxes, the owners of the corporation, the money goes to them and they have to pay taxes on that money. Okay. So let's move now to C corporation. And this is when we refer to a corporation, when, when, when we just say the word corporation and the real world, what we really mean is C corporation. This is what we mean by regular corporation. Now we are talking about really a different animal here, a different type of business. C corporation are subject to an entity level federal income tax, which result in what's known double taxation effect. Now C corporation, what's going to happen is this, they're going to compute the revenue, they're going to report the revenues minus expenses. They're going to get to something called, I mean, those are not the technical word, but I'm just illustrating the point, we're going to get to something called profit before taxes. Then the corporation's going to pay taxes. And it happens to be now 21%, which is easy. Then we're going to have net income. So what's different about C corporation, the corporation itself will pay the corporation itself will pay taxes. This is what's special about C corporation versus S corporation, the corporation S, which is what we saw here. No taxes, no taxes. The corporation itself won't pay taxes. Who pays taxes? The owners. Same thing with the partnership. But C corporation are a little bit different. And C corporation report its income and taxes and compute a flat tax rate of 21%. Now this wasn't that simple. It used to be, we used to have a progressive corporate income tax, but now it's 21%, which is easier for you as a student. And we report income and losses on form 1120, which I will show you shortly. When the corporation distribute income, the corporation shareholder report dividend on their income tax return. So let's go back and work some numbers. Let's assume we have $100,000 of income minus $60,000 of expenses. That's going to give us 40,000. Then we're going to pay 21%. So let me just calculate this real quick. So we're going to take 40,000 of profit before income taxes times 21%. We're going to pay taxes of 8,400. Now we're going to take 40,000 minus 8,400. And the corporation made a profit of 31,600. So what's going to happen is this. Now the corporation may or may not distribute the profit. So if they do distribute the profit, the profit goes to the owners. So let's assume we have two owners, owner A and owner B. Owner A and owner B. Now, and let's assume also for simplicity to illustrate the point, we're going to assume that the corporation is going to distribute all the profit and dividend, which is that's not how it happens in the real world. You don't have to distribute it and companies don't distribute it. And for simplicity, I'm just going to go 50,50. So we have two owners. So owner A is going to get 15,800 of dividend and owner B, 15,800. Now notice the profit from the company was taxed once here. Now what's going to happen, owner A will pay taxes on the 15,800. How much taxes? Well, it all depends on owner A tax rate. Owner B will have to pay taxes as well and how much you'll have to pay taxes based on tax payer B tax rate, whatever their tax rate, because each individual will have a different tax rate. So notice we pay taxes twice on the same amount of profit. The corporation paid 8,400, then the owners will pay each whatever their amount of share is. So it's double taxation. And if you want to simplify it, let's assume they pay 10%, each one of them pay 10%, just to simplify. So the taxes are paid twice. So hopefully you can see the point. Thus income that has already been taxed at the corporate level is also taxed on the shareholder level. So double taxation stems from the fact that dividend distribution are not deductible by the corporation. So when they distribute the dividend, the dividend is not deductible. So the dividend, when we distribute dividend, dividend is not an expense. Dividend is not part of operating the business. Dividend is part of financing, part of outgoing financing. So it's not an expense. So dividend is not an expense. So what happened? The government, they want to kind of alleviate this double taxation. What they did is they allow you an alternative special tax rate for dividend. So basically, we're going back to the qualified dividend income. And remember, it's taxed at 15%. It actually taxed at 0, 15 and 20. When is it taxed at 0%, low income taxpayer, which we're going to see the numbers later on. It's taxed at 20% when you're a high income taxpayer. But if you're in between, you're not too low, you're not too high, it's taxed at 15. So you might be asking yourself, hold on a second, could you give me when is it taxed at 0? When do you consider, you know, you are a low income taxpayer? We did it in a separate session. I'm going to show it to you again when we work an example. Just know you have three rates, 0, 15 and 20. 20 for the rich, I'm just putting a quote, 0 for not having a lot of money and 15 for people in the middle. Okay. And we're going to see them. Although don't worry about the term rich and all that. These rates also apply to long-term capital gain. Okay. So the 0, 15 and 20% applies to long-term capital gain as well as the dividend. So the same thing that you learned for long-term capital gain applies to dividend. Now, this is a C Corp. C Corp. Notice C Corp. Also, it looks C Corp per form, which is 11, 20. It also looks as income. And again, I used to prepare C Corp, but not as much as 11, 20, as in 10, 65. So when you are dealing with mom and pop, it's either, you know, small businesses, they're either 11, 20 S or 10, 65, mostly, or at least what I used to work. Okay. It doesn't mean I did not work with 11, 20s, but during the tax season, they were mostly 11, 20 S, S Corp in 10, 65, which is partnership. But this is what 11, 20 looks like. So basically you add all of your income and we're going to talk about their income. The way the income is reported is different than S Corp, but we'll talk about those topics when we cover the corporation itself. So we have income of 100,000 and we compute all the deduction. The deductions happens to be, I don't know, 60,000. Notice here it's taxable income before operating loss. Don't worry about that as well because we're going to talk about it later. So taxable income is 40,000. Okay. 100,000 minus 60,000 equal to 40,000. Don't worry about NOL. We'll talk about those and special deduction. We'll talk about those later. So notice, here's what I want you to see. I want you to see this, although I mentioned it and I talked about it, but I want you to see it physically. Line 31, it could be on a different line for a different year, but happens to be total tax. So notice the corporation will pay taxes. And I remember we just computed this if it's 21%. So they're going to pay, put it in a different color. They're going to pay 8,400. And this is something I did not do when I showed you the 1120S and when I showed you the 1065. And I pointed out that there's no tax, but regular corporation get taxed. Okay. I know I keep repeating myself in a different way. I told you, I showed you, but I also want to show it to you on the form. So this way it will stick in your mind. Because when you're studying for your CPA exam, you don't want to have any doubts about which one is a tax flow entity and which one is not. And what does that mean? I just want to make sure you have it. You have that strong foundation. Okay. So let's talk about corporation versus other form of business. Because if you notice the corporation was a little bit different than the other ones. The other ones are similar, especially in terms of taxation. When comparing C corporation to other businesses, there are a number of factors to consider. One is the tax rate. Now it's 21% flat rate, which is easier. But in prior year, we used to have a schedule, which I will show you in a moment. The character of the business income is important. Tax attribute of income and expenses don't pass to shareholders. We don't have something called separately stated items for corporations. Okay. And you will see what does that mean. When we talk about separately stated item. So if you have a tax favored income, you should not be operating as a C corporation. So let's assume your income comes from municipal bonds. Municipal bonds are not taxable. You don't want to form a C corporation and have their income flow through it. Because the tax attribute don't goes to you. As well as capital gains. Capital gains is the same thing. There's no such thing as long-term, short-term, capital gain. So you don't have any alternative or favorable tax because the corporation deals with that income all the same. Same thing with business losses. Losses are not passed to the shareholder, but retained by the corporation itself. However, partnership and S corporation and schedule C, you might be able to deduct some of that losses. Okay. Employment taxes. Sole proprietary ship taxpayer net income is subject to self-employment taxes, which is 15.3. And if you make too much money, there's an additional taxes. If you operate as a corporation, CNS wages are subject to payroll taxes. So you can be an employee and you're subject to payroll taxes. Now what's the difference between self-employment and payroll taxes? Well, you just have to sit down and make your computation to see which form of business is more favorable for you in terms of employment taxes. But those are some of the consideration you would take into account if you want to operate as a C corporation or partnership. If you have more than one owner, obviously, or a sole proprietary or an escort if you have one or more. Okay. And as I mentioned earlier, prior to 2018, the way S corporation computed their taxes was a progressive, for example, between zero and 50, 15%, between the additional 25,000. Now you're in the 25% tax bracket. Then from 25 to 100, it escalated very quickly, 34. And from 100 to 335, you'd be in the 39% tax bracket, so on and so forth. We no longer use this. Now it's a 21% flat rate with the Tax Cuts and Jobs Act of 2017. Let's take a look at an example to illustrate double taxation. Also, I illustrated, but let's take a look at it from a more formal example. So let's take a look at this. L corporation report taxable income of 100,000 in 2018. It pays corporate tax of 21,000. This leaves 79,000 of which all of it distributed as different to Ashley, who was 43 year old individual in the corporation sole owner. So here's what we have here. We have income of 100,000. Then the business pays taxes of 21,000. This leaves 79 taxes. So this is taxes paid by the business. And this 79,000 goes to Ashley. Ashley is the only owner. Now Ashley reports 79,000 of income, then Ashley is going to deduct 12,000 in standard deduction, which leave her taxable income of $67,000. And it's all dividend because there's money coming from the corporation. Now what's going to happen is this. This $67,000 is dividend. Therefore it's subject to 015 and 012 or 15 depending on her tax rate. So here's what's going to happen. The first 38,600, she's not going to pay any taxes on it. Why not? Because for the dividend, we have a special rate. Up to 38,600, you don't pay any taxes on this. So when she got the 67,000, the first 38,600, she's in the 0% tax bracket from a dividend perspective. Then the additional $100, it's subject to 12%. And you're going to see why this in a moment, 12%. Not in a moment. I'll show you the slide in scale in a moment. Then the remainder, the 28,300 is subject to 15%. At this point, once you reach, so notice, let me show you how this work. I know I did this before. You're supposed to know how to do this, but I will do it here. 38,600 plus 100, that's 38,700. So copy this number down, 38,700. Copy this number down. Notice up to 38,700, you're in the 12% tax bracket. As long as you are with zero and up to 38,000, I wish they made a 38,700, you pay zero on your dividend. So notice, but no, the number is for dividend 38,600. So notice the additional 100, you pay either 12% or 15. You either pay your ordinary rate or 15, whichever is lower. For the additional $100, you pay 12%. Now, anything above this level up until you reach around 400,000, you'll pay 15%. So that's why the remainder, which is 28,300 is subject to 15%. Now, if you are asking yourself, what the hell is he doing here? Go back to chapter 3. Chapter 3 and chapter 13. In chapter 3, I explain this, then in chapter 13, I explain this. You want to make sure you know this. So all in all, she pays taxes on her personal level of 4,257. So notice what happened. The corporation paid 21,000, I'm sorry, the corporation paid, yes, 21,000 in taxes. Let me highlight the taxes. The corporation paid 21,000 and she paid 4,257. So all in all, they paid taxes of 25,257 on the same, on that $100,000 of profit that the corporation experienced. Now let's assume Ashley operate her business as a sole proprietorship. What's going to happen is this. She's going to have $100,000 in profit. She's going to deduct her standard deduction. It's going to bring her down to 68 and she's going to deduct 20,000 for qualified business income. Okay. And what's going to happen, she's going to pay taxes of 10,900. As a result operating the business sole proprietorship result and 14,357 savings on her taxes. Okay. So basically, if you're saying, how did she compute the 10,900? I'll show you how we computed the 10,900 in a moment. But hopefully you see that the money is taxed once, which is 10,900. Now let's take 68,000. So what we do, we're going to go to the table and we say this is an individual and they fall within this tax bracket here. So the taxes are $4,453.50 plus she's in the 22% tax bracket. 68,000 minus 38,700 and that amount is 29,300 and that amount we're going to multiply it by 22% plus 6446 plus 6446. And this is how we computed the tax. Hope you should know how to do this. This is a review but plus 44,53 and that's the 10,900. And this is how you came up with 10,900 in taxes. So notice that profit from the business, if it's a sole proprietorship, it's only taxed once. Now you might be saying, why don't actually operate as a sole proprietorship? Well, there are other considerations which we'll see later other than taxes when you are operating a business. So let's take a look at a couple more examples. The first one is E&L. Ellie and Linda are equal owners in other enterprises, a calendar year business during the current year. The enterprise business has 320,000 in income and 210,000 in expenses. In addition, they have a long-term capital gain of 15,000 and makes distribution to Ellie and Linda of $25,000 each. So from the business, we make a distribution of $25,000. Discuss the effect of this information on the taxable income of Ellie and Linda if they operate as a partnership. So what is the effect if they operate as a partnership? The first thing you need to know the partnership is a not a tax paying entity. What's going to happen is this. They will take 320 minus 210 and that's going to be the profit for the business 110. Now again, this profit, what's going to happen, some of it is going to go to Ellie and some of it is going to go to Linda and they're going to pay taxes on that profit themselves. Remember, they also had a $15,000 of capital gain. Again, the $15,000 is not part of this. It's separately and it goes, some of it goes to Ellie, some of it goes to Linda on schedule K1. This also goes on schedule K1. So the profit is on schedule K1 as well as the capital gain. Now you have to remember that this $15,000 that goes on schedule 1, it's going to be subject to 0, 15 or 20% because it's a long-term capital gain and it's going to retain its character for them as a long-term capital gain. Now they took $25,000 out, each one of them took $25,000 out of the business. How is that going to affect their taxes? It's not going to affect their taxes. It's going to reduce and we'll see later what does that mean. But write it down, reduce their basis, reduce the basis in the business. Just write this down, we'll explain it later. So the $25,000 that they took out, it reduces the basis. This is if they are operating as a partnership. Now what happened if they are operating as a corporation? Guess what? Practically the same. They will take revenues minus deductions, we'll get $110,000 of income. That $110,000 is allocated to Ellie and Linda which they'll pay taxes on it and they're not telling us if it's 50, 50, 60, 40. It doesn't matter. Also the $15,000 is reported separately and also subject to the tax preferential treatment and the withdrawals also reduces their basis. But remember, when they reduce their basis, it cannot be below zero. Also write down, not below zero. And don't worry what this is for now. We'll talk about the basis later on. It's a topic on its own. Now let's move and assume, let me change colors here. And let's assume this business is operated as a C corporation. What would happen under those circumstances? Well, what would happen under those circumstances? We are going to have $320,000 plus $15,000 minus $110,000. Okay? So we're going to take the income from the business. That's the long-term capital gain minus the expenses from the business and that's going to give us taxable income of $125,000. Now, what's going to happen that $125,000? It's going to be subject to taxes. So, you know, they're going to be this $125,000. You know, they'll pay 21%. The corporation will pay 21% on it. Okay? That's how that's what happens. Okay. Then the $25,000 that went to Ely and Linda. Remember, they took $25,000 out of the business. This $25,000 is subject to 0, 15, and 20%. 0, 15, and 20%. Because they took it out. The withdrawals is considered here dividend. Okay? The withdrawals is considered dividend. But remember, the $15,000 is part of the corporation. So this $15,000 did not get any tax favorable treatment. So this is basically regular income. Considered regular income versus long-term capital gain. As far as the corporation is concerned, this is regular income. And again, we'll talk about this later on when we talk about the corporation. But the point is, we don't have separately stated item. That's the first thing I want you to see. So all the income is considered part of the corporation, subject to the taxes of the corporation. Then the withdrawals, the dividend, the $25,000 that each one of them got, is considered dividend, and it's subject to 0, 15, and 20%. Let's take a look at another example. Okay. Purple Company has $200,000 in their income for 2018 before deducting any compensation for other payment to sole owner, which is Christine. And Kristen happened to be single. She claims a $12,000 standard deduction. Purple Company is Kristen's only source of income, ignoring any employment tax consideration, compute her after tax income. Okay. So Purple is a sole proprietorship, and Kristen withdraw $50,000 from the business during the year. Okay. So Kristen claims a $40,000 deduction for qualified business income. So she's going to get this $40,000 deduction, 20,000 times 20%. So let's see what would happen if she, if she operate as a sole proprietorship. If she's operating this business as a sole proprietorship, what's going to happen is this. We have $200,000 of income minus $40,000 qualified business deduction, qualified business income deduction. Then she's going to take $12,000 and standard deduction. So all in all, the taxable income will be $148,000, $148,000. Now for a single, let's see how much $148,000 we pay taxes on this. So if we are dealing with $148,000, the individual is single. They fall within this tax bracket. So it's $14,000, $89 plus, she's in a 24% tax bracket, 24% of the amount above $82,000, $82,500. So again, what's the, it's $148,000, okay? So let's take $148,000, $148,000 minus $82,500. That's the excess amount, $65,500 and you're going to pay 24% on that. That's $15,720 plus, plus $15,720. So all in all, the taxes is $14,000, $89 plus, $15,720. That's $29,810. $29,810, okay? $29,810. So basically, that's the taxes that she pays. So simply put, if the business is bringing $200,000, she's going to have to pay $29,810. Therefore, the net take home basically after taxes from the business is $170,190, $170,190. This is Kristin's profit after she pays the taxes on the business. Now, and you might be saying, what about the $50,000 withdrawals? The $50,000 withdrawal, they are not taxable as sole proprietorship. They're not taxable, okay? Because the whole business, the whole income is taxable to her. Now, let's assume Purple is a C corporation and the corporation pays all of its after income tax as a dividend to Kristin. So here's what's going to happen now. Now we're going to have $200,000 of income before taxes. Then we're going to pay 21% taxes on this times 21%. This is how much the corporation will pay. So times 21%, that's $42,000. Now $200,000 minus $42,000 in taxes. That's going to give us basically corporation after tax income, $158,000. Now, what we said, we said all of this, all the $158,000 goes to Kristin in terms of dividend. So it goes to her. So $158,000 goes to her. Kristin's going to take the standard deduction, $12,000 and that's going to leave her with $146,000. That's taxable income. So notice the corporation, let me highlight this, the corporation already paid $42,000 in taxes on this $200,000. Then Kristin, her taxable income is $146,000. Now Kristin will have to pay taxes on that dividend. Kristin will have to pay taxes on that dividend. So $146,000 in taxable income, which is dividend. All of it is dividend. Therefore it's subject to 0, 15 and 20%. So now I have the rates for you for the 0, 15 and 20%. So 0% applies for a single taxpayer of the taxable income does not exceed. This is for married single $38,600. So up to $38,600, she doesn't have to pay any taxes on that dividend. Then as long as a single, you don't get to $425,800, you would pay 15%. So let's see. We said she has $146,000. So Linda has $146,000 in dividend. So here's what's going to happen. Of the $146,000, the first $38,600, she doesn't pay any taxes on it. Why? Because from a tax perspective, she's right here in this tax bracket minus $100. So up to 12%. She's in the 12% tax bracket minus $100. That's why I hate. I wish they made it $38,700. Then the additional $100 to make it $38,700 additional $100, she either pays 15% or 12%. She either paid the preferential treatment or her ordinary rate, whichever is lower. Her ordinary rate happens to be lower. Therefore, that's multiplied by 12%. She's going to pay on this amount, which is $12. Now, so of the $146,000, she already used up $38,700. Let's see what's left. $146,000, oops, not used up, already taxed $146,000. We already taxed $38,700, which is technically only $100 was taxed, but the other is tax-free. What left us with $107,300. Now we're going to take $107,300 and multiply it by 15%. Why 15%? Because her tax rate becomes 22, 24. Guess what? 15 is lower. They allow you to take 15%. Why? Because this is dividend. This $107,300 times 0.15, that's $16,095, $16,095. So $16,095 plus $12, her total tax on a personal return, $16107. That's her personal taxes. So notice what happened here. As a corporation, she paid on that $200,000, she paid personally $16,107, and the corporation paid $42,000. Notice all in all, that's more taxes than a sole proprietorship when we did A. Okay, let's take a look at C. In C, purple corporation is a C corp and the corporation pays Kristin a salary of $158,000. Now what's going to happen is this, we have $200,000. Then the corporation paid Kristin $158,000. Because in a corporation, you can employ yourself. You can be an employee of the corporation and that's a deduction for the corporation because you paid yourself. That's a salary. What's going to happen? That's going to keep the corporation with $42,000 of taxable income. Then the corporation is going to pay 21% taxes on this, which pays $8,820 in taxes. So the corporation pays $8,820. But remember, this $158,000, it's going to go on Kristin's W2. So it's going to be her gross income minus the standard deduction on a personal level, $12,000. What's going to keep her with $146,000. Now she's going to have to pay taxes on this $146,000. This is no longer dividend. This is not dividend. Okay, this is not dividend. What she did is she took the deduction. Now she's going to have to compute her taxes based on the $146,000. Therefore, you just come over here and this is where she stands. It's $14,000 plus 24% of the amount above $82,500. So all in all, if we compute her taxes under this scenario, all in all, she will pay $29,330 in taxes between what the corporation paid and what she paid. So $29,330. Now you can do your comparison saying, well, as a sole proprietorship, how much did I pay as A versus B versus C? And you could basically organize your strategy. What's the best way to do it? Is it better to take out the dividend? Okay, because Kristin's after tax income under B, if you remember this, after tax income under B, it was actually $141,893. So after she paid taxes on the dividend, after she paid taxes on the corporate money, it was $141,893. If you look under C, she's going to net $128,670 after paying taxes on the corporate level and paying taxes on the corporate level and paying taxes on her double. You just have to do those computation to figure out which is which. Let's take a look at non-tax issues and selecting an entity form. So yes, taxes play a big role in selecting how should you form your business, but there's also liability that plays a role. Sole proprietary and some partners have unlimited liability for claims against the entity and that's the reason why you don't operate as a sole proprietary or a general partner. So if you can be a limited partner or you can form an LLC or an escort, then you have limited liability. Capital raising, generally speaking, corporations and partner to a lesser extent can raise large amount of capital for entity venture. Remember, when you are pulling your resources with other people, then it's easier for you to raise money than if you were by yourself. Transferability, corporate stock is easily transferred, easily sold, but partners must approve partnership and so on. In a corporation, it's easy to transfer your ownership to another individual. Continuity of life in a corporation, the owners and the business are to have a separate life. So basically, the corporation exists indefinitely. Centralized management, corporate actions are governed by a board of directors, so the management is centralized. Partnership operation may be conducted by each partner without approval of the other partners. So those are non-tax issues. If you want to operate the business, how should you operate the business? The last type of business we're going to be discussing is the LLC. So the LLCs are state entities. So basically you would organize your business under an LLC for state entity. What's going to happen is this. Is an LLC a partnership, a corporation, or a sole proprietorship? And this is what's interesting about an LLC. As far as 1988, as far back as 1980, the IRS ruled that it would treat qualifying LLC as partnership. So it's an LLC. It's a limited liability company. It sounds like a corporation, but what we're saying is from an IRS perspective. So the IRS said, yes, it is. You might have incorporated it in your state or you might not have to. But from our perspective, we can also treat this from a tax perspective as a partnership. Now, why is this important as a partnership? Because as we learned earlier, if you are a partner, if you are treating your business as a partnership, the income is only taxed once. So what the IRS said, it comes with this regarded entity term. This regarded entity. Basically they're saying, I don't care how you are incorporated under the state. I'm willing to treat you as a partnership. You're going to see that. Now you have to tell the IRS if you want to be treated as a partnership. So it's this regarded entity in a sense that I don't care how you are organized. I can treat you differently. I can treat you, although you're a corporation, if you want to be treated as a for tax purposes as a partnership, I will treat you as a partnership. So it gives you the best of both worlds. What's the best of both worlds? It's going to give you a major non-tax advantage. So from a liability perspective, you are still a corporation. From a liability perspective, you are a corporation. So from a court's perspective, you are still protected. But from a tax perspective, the IRS says, look, I am willing to allow you to be treated as a proprietary or a partnership for that for tax purposes, which is good. It means you're not taxed twice. So it avoids the double taxation. And there was a lot of confusion about this. There was a lot of confusion until 1996 when the Treasury regulation, when the Treasury regulation based a Treasury department issued a regulation saying, just all you have to do now to tell us how you want to be treated, check the box regulation. And by the way, owners and an LLC are called members. So simply put, an LLC is a blended form of business. It has a corporation characteristic from a liability perspective and partnership characteristic from a tax perspective, partnership or escort, which is a pass through entity. So now what they're saying is check the box regulation. It allows the taxpayer when you start the business to choose the tax status of an uncorporated entity without regard to the corporate or non-corporate characteristics. So you don't have to tell us whether you are a corporation or a corporation. Just tell us how you want to be taxed. But generally speaking, entity with more than one owner can elect to be classified as a partnership or a corporation. So you tell them if you wanted to be a partnership or a corporation, entity with only one owner, obviously the partnership is not an option, can elect to be classified as a sole proprietorship or a corporation or an escort as well. If you made no election, if you have a multi-owner entity, so if you are a business with many owners, it's treated as a partnership. If you did not elect and you are a single business owner, you are treated as a sole proprietorship. So this is the LLC. So this is what we mean by disregarded entity. They don't care how you are corporated or incorporated. Just tell us how you want to be taxed basically. And this is the form that you fill out 8832. I'm not really familiar with the term that much. And it's not only this pages, multiple pages, but this is the form that you will tell the IRS how you want to be treated. And this is a summary of the different type of tax treatment of business forms. For example, this is the sole proprietorship, partnership, escort, regular C. Basically, it's a summary of everything that we said. If you want to pause it and look at it, that will be good. Now, if you're studying for your CPA exam, make sure you understand these topics very well because we're going to be covering each one of them. We're going to have maybe two chapters about partnership, two to three chapters about corporation and one or two chapters about S corporation. So basically, what we're actually doing here in this session, we are setting the ground and actually we're going to start with corporation. So the next topic I'm going to be covering is regular C corporation. Then we'll move into S, then we'll move into a partnership. But this is basically setting the ground, planting the seed for those topics. If you happen to visit my website for additional lectures, please consider donating. Good luck and study hard.