BUSINESS TAX OVERVIEW

Businesses are primarily concerned with profits, expansion of markets and increased sales. However, profits, inventory and even many expenses are subject to taxation.

RULES AFFECTING S CORPORATIONS

The cost of providing fringe benefits to those S Corporation shareholders with a greater than 2% interest must be reported as compensation to the shareholder. The amount is now deductible to the S Corporation, although it is not subject to FICA taxes.

ESTABLISH A FLEXIBLE BENEFITS (CAFETERIA) PLAN

These plans allow employees to convert taxable wages into non-taxable benefits. The most common are:

• Medical insurance premiums paid by the employee

• Child care expenses

• Un-reimbursed medical expenses

Within limits, employees defer part of their salary to pay for benefits they select from a menu of options. Amounts deferred are not subject to FICA tax, so in addition to reducing employees’ income tax, cafeteria plans reduce both the employer and employee’s FICA tax. Considering current rates that is a significant payroll tax savings.

EXPENSE ALLOWANCES ARE TAXABLE

When employees receive expense “allowances” instead of documenting expenses for reimbursement, employers must include the allowance in compensation on the employee’s W-2 form. The allowances are subject to withholding and FICA taxes.

CORPORATE INCOME TAX RATES *

WATCH OUT FOR STATE AND LOCAL TAXES

For some businesses, the state and local tax bite is increasing. To keep these taxes under control, you need to know the specific rules that apply in the states where you do business. For example, some states have an income tax; others have a franchise tax. Most have sales and use tax. State law determines the level and type of activities within a state that will generate a tax. Keeping receivables, inventory and supplies at a low level may reduce local property taxes.

DONATE EXCESS INVENTORY

Generally, you may deduct your cost of items donated to charity, not the higher market value. However, for C corporations, some inventory donations to charities qualify for larger deductions.

Donations of equipment to institutions of higher education or to certain scientific research organizations may qualify only if used in research training or research experimentation. The deduction is the cost plus half of the value in excess of the cost, but it is limited to no more than double the cost.

Donations that are used by a charity in its tax-exempt purpose of caring for the ill, needy or infants, may also qualify for the higher deduction.

STRUCTURE SHAREHOLDER LOANS CAREFULLY

To support your position that loans between you and your company are truly loans, structure them carefully. Otherwise, you may create negative tax consequences. Consider these features:

• A written loan agreement

• Loan approved by a board resolution

• Market interest rate charged

• Timely interest payments

• Collateral provided, if practical

• Short term instead of long term loans

• Record all liens

The longer the debt is outstanding, the more it looks like there was never any intention to repay it. The IRS could contend a loan to a shareholder was actually a taxable dividend, or that a loan from a shareholder was a capital contribution.

Therefore, it is important to make interest payments, and principal reductions. It is better to have a short term loan that is periodically revised, than a long term loan.

AVOIDING DEPRECIATION RECAPTURE

Tax-free incorporation is a highly desirable technique when a proprietor or partners want to sell business assets that would be subject to depreciation recapture.

It may happen that the partners have taken sizable deductions for accelerated depreciation, but now they feel the property should be sold. If they retain the partnership, they will have to report a great part, if not all, of the profit on the sale as ordinary income on their personal income tax returns.

However, if they incorporate that business before the property is sold, and if the corporation sells the property, the corporation is the one to report the ordinary income. This is true although the accelerated depreciation was originally deducted by the partners before the corporation existed.

Thus, the tax-free incorporation provides a way for partners to shift their tax liability from themselves to the corporation for any depreciation recapture. Investment credit, if any, can be handled the same way.

The corporation, rather than the individual owners, reports the recapture. However, for these rules to be applicable, all of the assets of the unincorporated business must be transferred to the corporation.

Source: Tax Facts, National Underwriter Company

Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice.