The Tax Environment

However, if the net operating loss was greater than the net operating income in both years, the residual would be carried forward in sequence to future profits in 2009 to 2028. Profits in each of these years would be reduced for tax purposes by the amount of the unused loss carried forward. This feature of the tax laws is designed to avoid penalizing companies that have sharply fluctuating net operating income.

Capitat Gains and Losses. When a capital asset (as defined by the Internal Revenue Service) is sold, a capital gain or loss is generally incurred. Often in the history of our tax laws there has been a differential tax treatment of capital gains income and operating income, with capital gains being treated more favorably. Under the Revenue Reconciliation Act of 1993, however, capital gains are taxed at the ordinary income tax rates for corporations, or a maximum of 35 percent. Capital losses are deductible only against capital gains.

Personal lncome Taxes

The subject of personal taxes is extremely complex, but our main concern here is with the personal taxes of individuals who own businesses - proprietors, partners, members (of LLCs), and shareholders. Any income reported by a sole proprietorship, partnership, or properly structured LLC becomes income of the owner(s) and is taxed at the personal rate. For individuals there are currently six progressive tax brackets: 10, 15, 25,28,33, and 35 percent. The marginal tax rates apply up to certain levels of taxable income, which vary depending on the individual's filing status - that is, single, married filing a joint return, married filing separately, or head of household. Even within a filing category, however, the taxable income levels that trigger the marginal tax rate will generally vary from year to year because they are indexed to account for inflation. There are also standard deductions and personal exemptions that enable those with very low income to pay no taxes.

lnterest, Dividends, and CapitaI Gains. For the individual, interest received on corporate and Treasury securities is fully taxable at the federal level. (Interest on Treasury securities is not taxable at the state level.) However, interest received on most municipal securities is exempt from federal taxation. Taxable interest is subject to the ordinary income tax rates. The current maximum dividend and capital gains tax rates for most (but not all) cash dividends received and realized net capital gains are both 15 percent for quali$ring taxpayers. Subchapter S. Subchapter S of the Internal Revenue Code allows the owners of small corporations to elect to be taxed as an S corporation.In making this election, the company gets to use the corporate organization form but is taxed as though the firm were a partnership. Thus the owners are able to avail themselves ofthe legal advantages extended to corporations, but are able to avoid any tax disadvantages that might result. They simply declare any corporate profits as personal income on a pro rata basis and pay the appropriate tax on this income. This treatment eliminates the double taxation normally associated with dividend income - that is, the corporation paying dividends from after-tax income, and shareholders paying taxes on the dividend income they receive. In addition, stockholders active in the business may deduct any operating losses on a pro rata basis against their personal income.

As discussed earlier, a limited liability company (LLC) provides benefits similar to those of an S corporation, but with fewer limitations (e.g., no restriction as to the number and tlpe of owners). Many predict that the LLC form of business will grow in numbers to surpass the S corporation form.