Traditional Year-End Planning for Regular "C" Corporations
- Should A Closely-Held “C” Corporation Pay Dividends Rather Than Year-End Bonuses To Its Owners? Since a “C” corporation can generally deduct a bonus, and cannot deduct a dividend, the advisability of paying a shareholder/employee a dividend in lieu of a year-end bonus depends largely on the tax rates of both the corporation and the shareholder. If your corporation is experiencing the effects of the recession and would receive little or no tax benefit from a year-end bonus deduction, then a dividend paid in 2011 taxed at a maximum rate of 15% may save overall taxes. On the other hand, if your corporation has significant income and is currently in a high tax bracket, then a bonus paid in 2011 may save overall taxes. Planning Alert! If you decide that a year-end bonus would be more tax beneficial, be sure that you can justify the reasonableness of the bonus. If your corporation pays compensation to a shareholder/employee that is considered unreasonably high, the IRS may attempt to re-classify the payment as a dividend payment. Therefore, the corporation should document the reasonableness of compensation paid to all shareholder/employees.
- Properly Document Loans To Shareholders. If you borrow from your closely-held corporation, you should make sure there is a written agreement to repay your loan, a fair interest rate is charged, and the loan is authorized by a corporate resolution. Without adequate interest and proper documentation, the IRS may treat your loans as constructive distributions which could result in dividend treatment and double taxation. Planning Alert! A corporation should charge interest at least equal to the Applicable Federal Rate (AFR) on loans to shareholders. Otherwise, subject to certain exceptions, the IRS will impute interest and the imputed interest (in excess of the interest actually charged) will result in dividend treatment if the corporation has earnings and profits.
Traditional Year-End Planning for "S" Corporations
- Properly Account For Health Insurance Premiums For S Corporation Shareholders ‑ Including Medicare Premiums. Generally, if you own S corporation stock and the S corporation pays for your health insurance premiums, IRS says you can take an "above‑the‑line" deduction (i.e., unrestricted by the 7½% subtraction as an itemized medical expense deduction) for the premiums on your personal tax return if the S corporation timely reports the cost of the premiums paid on your W‑2 as wages. However, if the medical insurance policy is your personal policy, the IRS says that your S corporation must pay the premiums directly, or reimburse you for the premiums before the end of the year and timely report the payment (or reimbursement) on your W‑2 as wages for you to take an "above‑the‑line" deduction on your personal return. Planning Alert! Make sure your S corporation complies with these rules so you will not be limited to a deduction only for the premiums in excess of 7½% of your AGI. Tax Tip. The above rules apply to premiums paid or reimbursed for you, your spouse, your dependents, and any of your children under age 27 at the end of the year (even if the child does not qualify as your dependent). In addition, the IRS has clarified that Medicare premiums qualify as medical insurance premiums. Therefore, the above rules also apply if the S corporation reimburses or pays your Medicare premiums.
- Check Your Stock And Debt Basis Before Year End. If you think your S corporation will have a taxable loss this year, you should contact us as soon as possible. These losses will not be deductible on your personal return unless and until you have adequate “basis” in your S corporation. Any pass-through loss that exceeds your “basis” in the S corporation will carry over to succeeding years. You have basis to the extent of the amounts paid for your stock (adjusted for net pass-through items and distributions), plus any amounts you have personally loaned to your S corporation. Tax Tip. It may be possible to restructure an outside loan to your corporation in a way that will give you adequate basis. However, this restructuring must occur before the end of the tax year. Planning Alert! Making sure that you have sufficient basis is particularly important in 2011 if your S corporation anticipates generating losses from the 100% §168(k) bonus depreciation deduction. The rules for restructuring existing loans to an S corporation to ensure basis are complicated. Please do not attempt to restructure your loans without contacting a CPA first. Also, if you finance losses of an S corporation with loans from other entities controlled by you, or if you borrow from another shareholder, the IRS may take the position that these loans do not give you basis. It is best not to finance S corporation operations with funds borrowed directly from related entities or from other shareholders
- Salaries For S Corporation Stockholder/Employees. For 2011, an employer must pay FICA taxes of 7.65% of an employee’s wages up to $106,800 and FICA taxes of 1.45% on wages in excess of $106,800. In addition, for 2011, an employer must withhold FICA taxes from an employee’s wages of 5.65% on wages up to $106,800 (normally 7.65%, but reduced to 5.65% for 2011 only) and 1.45% of wages in excess of $106,800. If you are a stockholder/employee of an S corporation, this FICA tax is generally applied only to your W-2 income from your S corporation. Other income that passes through to you or is distributed on your stock is generally not subject to FICA taxes or to self-employment taxes. Planning Alert! If the IRS determines that you have taken an unreasonably “low” salary from your S corporation, the Service will generally argue that other amounts you have received from your S corporation (e.g., distributions) are disguised "compensation" and should be subject to FICA taxes. Determining "reasonable salaries" for S corporation shareholder/employees is a hot audit issue, and the IRS has a winning record on taking taxpayers to Court on this issue. The IRS has been particularly successful where S corporation owners pay themselves no salary even though they provided significant services to the corporation. Caution! Determining a "reasonable" salary for an S corporation shareholder is a case‑by‑case determination, and there are no rules of thumb for determining whether the compensation is “reasonable.” However, this case makes it clear that salaries to S corporation shareholders should be supported by independent data (e.g., comparable industry compensation studies), and should be properly documented and approved by the corporation. Planning Alert! Keeping salaries low and minimizing your FICA tax could also reduce your Social Security benefits when you retire. Furthermore, if your S corporation has a qualified retirement plan, reducing your salary may reduce the amount of contributions made to the plan on your behalf since contributions to the plan are based upon your “wages.”
Next week, we'll be back to discuss some final traditional year-end planning tips. In the meantime, if you have any questions, please do not hesitate to contact our Firm.
brad@mcarthurco.com
704.544.8429
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