Category: IRS – Hot Topics

Accumulated Earnings Tax – C Corporations

Accumulated Earnings Tax – C Corporations

The C-Corporation, as an entity, is subject to corporate level tax on its net income or profits.  Once taxed at the corporate level, the remaining “after tax” profits can be distributed as dividends, paid as bonuses, or retained by the company.  Excess profits re-invested back into the company are referred to as retained earnings.  Generally, a reasonable amount of retained earnings, or retained earnings specifically ear marked for future company expansion or major equipment purposes are not scrutinized by the IRS.  If the IRS deems accumulated earning to be excessive as compared to the reasonable needs of the company, the IRS can take the position the dollars represent unpaid dividends.  The accumulated earnings tax of 39.6% (individual rate) will apply in addition to the regular corporate tax. Remember unlike a salary or bonus, a dividend is not deductible by the company.  But be cautious, before you get the idea of clearing the retained earnings account by paying large salaries or bonuses to the owner(s) read the excessive compensation article elsewhere in our Blog.

What’s the answer – better and proactive tax planning!

Finally learn how to keep more of the money your business earns!  Call us for help or with questions!

The Business Wealth Preservation Group is a professional services firm dedicated to providing superior individualized and custom service to individuals and their businesses in the areas of asset protection, tax planning, exit strategies, and wealth building. Simply put – we want to educate you on all relevant opportunities to put more dollars into your pocket, your business and your future.

We focus on leading edge, sophisticated, and safe business strategies that will help business owners structure, operate and maintain their business to take advantage of business and tax laws rather than being encumbered by them. We partner with the business, the accountant, and the attorney to ensure the business owners are capturing all available benefits that align with their business and personal goals.

www.BusinessWealthPreservation.com
Call Us Toll Free: (888) 938-2975 (888-WE-TAX PLAN)
Email: tfoster@wetaxplan.com

Retained Earnings – S Corporations

Retained Earnings – S Corporations

Although an S-Corporation does not have the excessive earnings tax issues that a C-Corporation, we do see many businesses, taxed as S-Corporations, that have large retained earnings.   Do you know why the IRS doesn’t have a problem when an S-Corporation has large dollars, or strike that, large numbers in the retained earnings account?  It’s simple.  You, the business owner, have already paid all the taxes due.   The S-Corporation has no corporate level tax, and you have already paid the individual income taxes on the one time business profit.

If you don’t remember, it went like this.  In 2007, your S-Corporation business had taxable net profits of $100,000, that number was reflected on your personal return, and you paid taxes on it.  But, because of cash flow issues, you only paid yourself $60,000.  The other $40,000 was reflected as retained earnings.  The concept of paying tax on $100,000 even though you only received $60,000, is clearly one of the negatives of being taxed as an S-Corporation.  As a side note, this situation can be avoided with better tax planning.

If the above situation sounds familiar, you might be staring at a financial statement that indicates you have hundreds of thousands of dollars in retained earnings.  The positive side is you have hundreds of thousands of after-tax dollars that is yours for the taking – tax free.  The cruel reality is you don’t have the “actual” cash to take it out.  Try putting $100,000 of retained earnings in your personal bank account without the check to go with it.

The good news, with better tax planning, in addition to better business revenue and profitability, you can develop a plan to get these tax free dollars out of the business over time.  The plan must include the payment of a reasonable salary amount in addition to the tax free distributions.

What’s the answer – better and proactive tax planning!

Finally learn how to keep more of the money your business earns!  Call us for help or with questions!

The Business Wealth Preservation Group is a professional services firm dedicated to providing superior individualized and custom service to individuals and their businesses in the areas of asset protection, tax planning, exit strategies, and wealth building. Simply put – we want to educate you on all relevant opportunities to put more dollars into your pocket, your business and your future.

We focus on leading edge, sophisticated, and safe business strategies that will help business owners structure, operate and maintain their business to take advantage of business and tax laws rather than being encumbered by them. We partner with the business, the accountant, and the attorney to ensure the business owners are capturing all available benefits that align with their business and personal goals.

www.BusinessWealthPreservation.com
Call Us Toll Free: (888) 938-2975 (888-WE-TAX PLAN)
Email: tfoster@wetaxplan.com

Excessive Business Owner Compensation – C Corporation

Excessive Business Owner Compensation – C Corporation

The IRS permits a business to deduct as a business expense, a “reasonable” salary, as compensation for services performed by employees and business owners.  For obvious reasons, the owner’s salary if deemed to be excessive in relationship to services performed, industry standards, and geographical location, could potentially be reclassified by the IRS as a partial dividend.  One of the significant differences of how a C Corporation is taxed, is the potential for double taxation.  Corporate profits are taxed once at the corporate level, and taxed again when they are paid to the owner(s).  Hence the double tax concept.

In an ill-advised attempt to avoid this double taxation, business owners and their advisors pay all “excess” money out to the owners as salaries.  Salaries paid to owners are 100% deductible by the company as an ordinary and necessary business expense.  Dividends on the other hand are not deductible by the company.  Hence the desire to pay salary in lieu of  dividends.  This however, is exactly why this issue is attractive to the IRS.  The portion of the salaries deemed to be excessive would be reclassified as a dividend.  As a dividend, the expenditure is not deductible, so the company would have additional income, resulting in additional taxes, penalties, and interest.  The payroll tax previously paid by the company would be forfeited.  The penalties generally are equal to the tax due.  Obviously, not a good situation for the company and a very expensive lesson.

So how can this be avoided?  Strategic, and proactive tax planning, entity structuring, and choice of entity planning can avoid these problems by creating other acceptable and tax friendly owner compensation options.

Finally learn how to keep more of the money your business earns!  Call us for help or with questions!

The Business Wealth Preservation Group is a professional services firm dedicated to providing superior individualized and custom service to individuals and their businesses in the areas of asset protection, tax planning, exit strategies, and wealth building. Simply put – we want to educate you on all relevant opportunities to put more dollars into your pocket, your business and your future.

We focus on leading edge, sophisticated, and safe business strategies that will help business owners structure, operate and maintain their business to take advantage of business and tax laws rather than being encumbered by them. We partner with the business, the accountant, and the attorney to ensure the business owners are capturing all available benefits that align with their business and personal goals.

www.BusinessWealthPreservation.com
Call Us Toll Free: (888) 938-2975 (888-WE-TAX PLAN)
Email: tfoster@wetaxplan.com

Employee vs. Independent Contractor – Tips for Business Owners

Employee vs. Independent Contractor – Tips for Business Owners

If you are a small business owner, whether you hire people as independent contractors or as employees will impact how much taxes you pay and the amount of taxes you withhold from their paychecks. Additionally, it will affect how much additional cost your business must bear, what documents and information they must provide to you, and what tax documents you must give to them.

IRS Guidelines

Three characteristics are used by the IRS to determine the relationship between businesses and workers: Behavioral Control, Financial Control, and the Type of Relationship.

1. Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.

2. Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker’s job.

3. The Type of Relationship factor relates to how the workers and the business owner perceive their relationship.

It is critical that you, the business owner, correctly determine whether the individuals providing services are employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.

Think of it like this:

To be classified as an independent contractor:

  1. Business owner can specify “what” is to be done not “how”  (Control Test)
  2. Does the person in question have their own tools, business cards, and invoices?
  3. Best Answer – Have the independent contractor set up an LLC.

Advantages of having the independent contractor set up a separate LLC

- Separate legal entity

- Contractor can now benefit from business tax planning

- Contractor can set up compensation, fringe benefit, and retirement planning

- Significantly reduces audit risk for both parties


Copyright 2010 The Business Wealth Preservation Group, LLC.