AC430 Unit 2 Entity Selection Memo Example

One Investor Abroad, Two Veterinarians and $600,000: A Unit 2 Entity Selection Memo for an Imaging Practice

[Student Name]

Purdue University Global

AC430: Advanced Tax - Corporate

Unit 2 Entity Selection Memo

[Instructor Name]

[Date]

The practice, its owners and every projection are composite; the statutes and regulation cited are real, and rates are those in effect for 2025.

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To: Dr. Imani Brooks, Dr. Paul Lindqvist and Mr. Henrik Aalto From: Tax staff Date: September 8 Subject: Choice of entity for the imaging practice

Recommendation

Organize as a C corporation. On these projections it produces about $100,800 less tax in the first year than a partnership, keeps the investor out of the United States tax filing system as a partner, and retains capital for the second scanner the practice plans to buy. The S corporation is not available while Mr. Aalto is an owner.

Facts

Projected operating income: $600,000 a year after market salaries for both veterinarians. Ownership in equal thirds. Distribution policy: half of what remains after any entity-level tax is paid out each year. Mr. Aalto lives in a country whose income tax treaty with the United States sets a 15 percent rate on portfolio dividends. Both veterinarians' households have other income placing them in the 35 percent bracket.

The S Corporation Is Not Available

A small business corporation may not have a nonresident alien as a shareholder (S Corporation Defined, 2024). Mr. Aalto's ownership therefore makes the election impossible, and the memo does not compute an option the owners cannot choose.

Comparison for the First Year

C corporation:

1. Corporate tax at 21 percent on $600,000: $126,000 (Tax Imposed, 2024). After tax: $474,000.

2. Dividends: half, $237,000, or $79,000 to each owner.

3. Veterinarians: qualified dividends at 15 percent plus 3.8 percent net investment income tax, $14,852 each.

4. Mr. Aalto: 15 percent treaty rate withheld at source, $11,850.

5. Total first-year tax: $167,554, with $237,000 retained.

Partnership:

1. Each owner is allocated $200,000, whether or not it is distributed.

2. Veterinarians: veterinary medicine is a health service, so above the income threshold no qualified business income deduction is allowed (Qualified Business Income, 2024). Income tax at 35 percent, $70,000 each; self-employment tax of about $27,193 each on $184,700 of net earnings, with the Social Security portion capped at the $176,100 wage base.

3. Mr. Aalto: his share is income effectively connected with a United States business, and the partnership must withhold at 37 percent, $74,000, under Section 1446 (Withholding of Tax on Foreign Partners, 2024). He must also file a nonresident return each year.

4. Total first-year tax: about $268,386.

The partnership taxes all $600,000 now and at higher rates, while the corporation taxes $600,000 at 21 percent and only the half that is paid out a second time, so on this distribution policy the corporation is cheaper even after both layers.

The difference, about $100,800, is not permanent. The $237,000 retained will face dividend tax when it is eventually paid out, or capital gain tax when the owners sell. But deferral has value, and the practice wants the cash for equipment.

Other Considerations

The practice's stock would not qualify for the small business stock exclusion, because health services are excluded from that provision (Partial Exclusion for Gain, 2024). Losses in a start-up year would stay inside the corporation. The veterinarians' salaries must be reasonable for the work done, since amounts above that could be treated as disguised dividends.

Mr. Aalto's position deserves its own paragraph. As a partner he would be treated as engaged in a United States business, file a return every year and face withholding on income the partnership might not distribute. As a shareholder he receives dividends only when they are paid, with tax withheld at the treaty rate and no United States return required for that income. For a passive investor, that difference may matter more than the rate comparison. Both forms protect the owners from the practice's debts if organized under state law as a corporation or a limited liability company, so liability does not separate the options here.

What Would Change the Answer

1. If Mr. Aalto sold his interest to a United States citizen or resident, an S corporation would become possible and would remove the second layer on distributions.

2. If the owners planned to distribute nearly all profit, the corporate advantage would shrink sharply.

3. If the practice expected losses for its first two years, a partnership would let the veterinarians use those losses on their own returns.

4. State income taxes, which this memo does not compute, could narrow or widen the gap.

References

Partial Exclusion for Gain From Certain Small Business Stock, 26 U.S.C. § 1202 (2024).

Qualified Business Income, 26 U.S.C. § 199A (2024).

S Corporation Defined, 26 U.S.C. § 1361 (2024).

Tax Imposed, 26 U.S.C. § 11 (2024).

Withholding of Tax on Foreign Partners' Share of Effectively Connected Income, 26 U.S.C. § 1446 (2024).