Corporate Taxation Israel and U.S.

Obama’s Jobs Act allows small business to sell up to $1,000,000 of its securities every 12 months and depending upon their net worth and revenue, individual investors are permitted to invest up to $100,000 in crowd-funding issuances every 12 months with much less regulation than before.

Dov Weinstein & Co. C.P.A. (Isr) is registered with the PCAOB and we belong to an international group of accounting firms and are able to cater to the needs of small and medium sized businesses in Israel and the United States. We assist small and medium sized businesses making connections within our international network of professional accounting firms, assisting to entrepreneurs help them rise up and raise capital.

Below are the various corporate structures available in Israel and the United States.

In Israel there is one type of corporate structure, in the United States there are 3 major types.

ISRAEL

In Israel there is one form of company, a Limited Liability Corporation. All profits earned in the company are taxed at a flat rate of 25% per year. This company is very easy to establish and the tax is easy to manage. The disadvantage is that this is a very inflexible structure.

UNITED STATES

Corporations in the United States are formed under the laws of each state under which they are registered.

To register a business as a corporation, certain documents are required to be filed with the states Company Registrar, typically with the state’s Secretary of State Office.

C Corporation

What is it?

A C Corporation is an independent and distinct legal entity.C Corporation refers to any corporation that, under United States federal income tax law, is taxed separately from its shareholders. Most major companies are treated as C Corporations for U.S. federal income tax purposes. A corporation may qualify as a C Corporation without regard to any limit on the number of shareholders, foreign or domestic.

Tax

When a corporation is formed, it is formed as a separate tax-paying entity. So the corporation itself, not the shareholders that own it, are held legally liable for the actions and debts the business incurs.

In some cases, corporations are taxed twice – first, when the company makes a taxable profit, (using the corporate income tax rates shown in the table below), and again when dividends are paid to shareholders in their personal tax returns.

Shareholders who are also employees pay income tax on their wages. The corporation and the employee each pay one half of the Social Security and Medicare taxes, but this is usually a deductible business expense.

For regular income tax purposes, a system of graduated marginal tax rates is applied to all taxable income, including capital gains. Through 2011, the marginal tax rates on a corporation’s taxable income are as follows:

Advantages of a Corporation

Limited Liability. The primary advantage of a corporation is that its owners, known as stockholders or shareholders, are not personally liable for the debts and liabilities of the corporation. For example, if a corporation gets sued and is forced into bankruptcy, in most cases, the owners will not be required to pay the debt with their own money. If the assets of the corporation are not enough to cover the debts, the creditors cannot, in most circumstances, go after the shareholders, directors or officers of the corporation to recover any shortfall.

Ability to Generate Capital. Corporations have the ability to sell ownership shares in the business through stock offerings. “Going public” through an initial public offering (IPO) is a major selling point in attracting investment and to raise funds for their business.

Corporate Tax Treatment. Corporations file taxes separately from their owners. Owners of a corporation only pay taxes on corporate profits paid to them in the form of salaries, bonuses and dividends, while any undistributed profits are taxed at the corporate rate, which is usually lower than the personal income tax rate.

Attractive to Potential Employees. Corporations are generally able to attract and hire high-quality and motivated employees because they offer competitive benefits and the potential for partial ownership through stock options.

Disadvantages of a Corporation

Time and Money. Corporations are costly and time-consuming ventures to start and operate. Incorporating requires start-up, operating and tax costs that most other structures do not require.

Double Taxing. In some cases, corporations are taxed twice – first, when the company makes a profit, and again when dividends are paid to shareholders.

Additional Paperwork. Because corporations are highly regulated by federal, state, and in some cases local agencies, there are increased paperwork and recordkeeping burdens associated with this entity.

S Corporation

What is it?

S Corporation is a regular corporation that has elected “S Corporation” tax status. The S Corporation itself does not pay any income tax, all business profits “pass through” to the owners, who report them on their personal tax returns.

To be considered a S Corp, you must first charter a business as a corporation in the state where it is headquarted. To qualify to make the S Corporation election, the corporation’s shares must be held by resident or citizen individuals or certain qualifying trusts.

Tax

A S Corporation is not itself subject to income tax; rather, shareholders of the S Corporation are subject to tax on their pro rata shares of income based on their shareholdings.

A S Corporation calculates its income just like a regular corporation. However, rather than taxing the corporation the corporation on those profits, the corporation’s owners get taxed on their shares of the corporation’s profit.

S Corporations allow shareholder employees to save on payroll taxes. For an S Corporation shareholder-employee, payroll taxes are only levied on the portion of the profit that the corporation labels “salary”. However, the corporation has to be reasonable in what it labels “salary”.

Advantages of a S Corporation

Tax Savings. An eligible domestic corporation can avoid the double taxation of a C Corporation by making a special election with the IRS to be taxed as a S Corporation. That way, there is only one level of taxation.

Another benefit of the S Corp is the tax savings. Only the wages of the S Corp shareholder who is an employee are subject to employment tax. The remaining income is paid to the owner as a “distribution”‘ which is taxed at a lower rate, if at all.

Business Expense Tax Credits. Some expenses that shareholder/employees incur can be written off as business expenses. Nevertheless, if such an employee owns 2% or more shares, then benefits like health and life insurance are deemed taxable income.

Independent Life. A S Corp designation also allows a business to have an independent life, separate from its shareholders. If a shareholder leaves the company, or sells his or her shares, the S Corp can continue doing business relatively undisturbed. Maintaining the business as a distinct corporate entity defines clear lines between the shareholders and the business that improve the protection of the shareholders.

Disadvantages of an S Corporation

Stricter Operational Processes. As a separate structure, S Corp’s require scheduled director and shareholder meetings, minutes from those meetings, adoption and updates to by-laws, stock transfers and records maintenance.

Shareholder Compensation Requirements. A shareholder must receive reasonable compensation. The IRS takes notice of shareholder red flags like low salary/high distribution combinations, and may reclassify their distributions as wages. Shareholders could pay a higher employment tax because of an audit with these results.

LLC Corporation

What is it?

A limited liability company is a type of business entity that combines the personal liability protection of a corporation with the tax benefits and simplicity of a S Corporation. The LLC remains a limited liability company from a legal standpoint, but for tax purposes it’s treated as an S Corp.  Owners of an LLC are called members. When you register your business you must indicate that it’s an LLC.

Tax

An LLC is not a separate tax entity like a C Corporation; it is what the IRS calls a pass through entity. All of the profits and losses of the LLC pass through the business to the LLC members, who report this information on their personal tax returns. The LLC itself does not pay federal income taxes, but some states do charge the LLC itself taxes. The IRS taxes a LLC depending on the number of members in your LLC.

Advantages of an LLC

Limited Liability. All members are protected from personal liability for making business decisions or actions of the LLC. This means that if the LLC incurs debt or is sued, members’ personal assets are usually protected. This is similar to the liability protections afforded to shareholders of a corporation. Keep in mind that “limited” liability – means that members are not necessarily shielded from wrongful acts, including those of their employees.

Less Recordkeeping. An LLC’s operational ease is one of its greatest advantages. Compared to an S-Corporation, there is less registration paperwork and there are smaller start-up costs.

Sharing of Profits. There are fewer restrictions on profit sharing within an LLC, as members distribute profits as they see fit. Members might contribute different proportions of capital and sweat equity. Consequently, it’s up to the members themselves to decide who has earned what percentage of the profits or losses.

Disadvantages of an LLC

Limited Life. In many states, when a member leaves an LLC, the business is dissolved and the members must fulfill all remaining legal and business obligations to close the business. The remaining members can decide if they want to start a new LLC or part ways. However, you can include provisions in your operating agreement to prolong the life of the LLC if a member decides to leave the business.

Self-Employment Taxes. Members of an LLC are considered self-employed and must pay the self-employment tax contributions towards Medicare and Social Security. The entire net income of the LLC is subject to this tax.