Business and Entity Planning for Individuals
Business and Entity Planning for Individuals
This domain tests how business ownership affects an individual's financial plan: entity choice, compensation, benefits, basis, self-employment tax, QBI, and succession.
Core rules and concepts
- Sole proprietorship: simple, but unlimited liability and self-employment tax on net earnings.
- Partnership/LLC: flow-through taxation, flexible allocations, self-employment tax issues for active members.
- S corporation: flow-through taxation, payroll required for reasonable compensation, distributions not subject to payroll tax, basis and shareholder limits.
- C corporation: entity-level tax, potential double taxation, but fringe-benefit and retention planning options.
- QBI deduction: generally 20% of qualified business income, subject to wage and income limitations.
- Buy-sell agreements: funded by life or disability insurance, valuation method, and ownership transfer terms.
- Succession and key-person planning protect continuity and value.
Worked example
An S-corporation owner has $300,000 of profit. The owner takes $120,000 as W-2 salary and $180,000 as distributions. Payroll taxes apply to the $120,000 salary, not the $180,000 distribution, but the salary must be reasonable for the services. The adviser should document comparable compensation, test the QBI deduction, and confirm the shareholder has sufficient basis to deduct losses or receive tax-free distributions.
Traps
- Setting unreasonably low S-corporation salary.
- Ignoring basis limitations on losses and distributions.
- Treating an LLC as automatically tax-free.
- Leaving a buy-sell unfunded or outdated.