Q-1:

Subject:  Small Business asking for a little help or direction.

Dear Kerry,

I came across your website while researching corporate tax information and was very impressed with the information and your desire to limit tax liability.

I was hoping you could offer a little help on my businesses.

Last year I purchased 3 small businesses from a single owner. The businesses sell very similar products, but are run as 3 separate corporations. 2 are “C” corps and 1 is a “S” corp. All located in Chicago, IL. Combined total annual sales of $2.8 million for all 3 companies.

I hired a new accounting firm to review my financials, do tax planning and file annual tax returns.

They are strongly recommending I change the 2 “C” corps into “S” corps. To avoid the future possibility of “double taxation” on dividend payments and keep things simple by changing all 3 companies to a true calendar fiscal year.

Historically over the last 10 years these businesses have never paid dividends. So I don’t see the benefit. The previous owner managed expenses across the 3 companies to avoid paying excessive taxes and never paid himself dividends just a nice salary.

After doing some research on line and reading your web site I feel like I have received some very bad advice. I believe I need to find a new accounting firm that has my best interests in mind. Also, with the new administration coming in January I think keeping my income as low as possible on my 1040 will be more important than ever.

I want to aggressively manage the businesses to limit my tax liability and I need a financial firm who thinks the same way.

Can you kindly offer some advice on how to proceed.

I would love for you to handle my financials or provide financial advice.

Any advice, direction or referral you can offer would be greatly appreciated. Do you know of a good professional tax advisor near Chicago?

Thank you in advance for your time and response.

Thanks and Best Regards,

A-1:

You are correct in recognizing the fact that your current accountant is not looking out for your best interests.  Unfortunately, there is no shortage of lazy short-sighted tax pros who try to force everyone into a one size fits all approach, often just using S corps.

As I have been preaching for decades, there are huge tax and liability saving opportunities by using multiple corps with different fiscal years.  The ability to smooth income out and even multiply certain tax breaks, such as Section 179, can save huge amounts of money in taxes. As I have explained countless times, the big fear of double taxation is crazy.  Any creative tax advisor worth his/her salt can find methods to shift income in ways that avoid the same money being taxed twice.

Using nothing but S corps for profitable businesses is completely counter-productive, especially in this environment.  That puts everything onto your 1040.  With the incoming administration in DC hyping the fact that they intend to soak people in the upper income levels, adding more income to your 1040 will just make you a more attractive and inviting target for more of your income to be confiscated and spread around. Unless you agree with that definition of being “Patriotic,” the goal for preserving more of your hard earned income should be to take steps to keep your 1040 income down as low as possible and slide under the radar of the Socialists who are now in charge of our lives.

I am still not at a point where I can accept any new clients; so you will need to keep looking for someone who will help you reduce your taxes instead of trying to structure things to make it easier on themselves, as it sounds like your current accountant is doing.  You may want to start with the tax pro who helped the previous owner of the businesses because it sounds like s/he understands how to work with multiple entities in a tax efficient manner.

Unfortunately, we don’t have anyone specific to whom we could refer you. I did recently post some names and links for some like-minded tax pros around the country.  

If you haven’t already done so, you should check out my tips on how to select the right tax preparer for you.  
You should note that geographic location should not be the main criterion for selecting a tax pro.

I wish I could be of more assistance; and I wish you the best of luck.

Kerry Kerstetter

Q-2:

Dear Kerry,
Thank you very much for your detailed response and advice. We are in agreement on the correct strategy for limiting taxable income for my businesses and on my 1040. I have begun a search for a new tax pro who will have my best interests in mind.
I greatly appreciate your comments.
Would it be possible to add my name to you waiting list of potential customers should you ever be ready for additional clients?
Please let me know.
Thanks again for your response.

A-2:

I will keep you posted if my workload ever allows me to accept any new clients.  I do have several names already on the waiting list; so I will be very selective as to the criteria any new clients must meet.

One of the most important factors will be that they are already up and running with proper accounting on QuickBooks for each of their entities.

Good luck.

 Kerry Kerstetter

Q:

Subject:  C or S corporation, no employees/partners

I am not sure if you reply to emails asking for additional advice, but I’ll give it a shot.
 
I am starting a marketing company in Ca. with no employees. (new babies, need money)
 
I do have a full time job, and this will be on the side.
 
>From your article a C corporation makes more sense for me.
 
But, I am scared of ticked off tigers, cobras, AK-47s, and the IRS.
 
Will I be asking for trouble if my company makes no money, and I decide to end the corporation in a year or so?
 
Does my separate tax return get red-tagged if I start a corporation that does/does not make money?
 
Thank you in advance for your time.

A:

You really need to be working with an experienced professional tax advisor to set up the best strategy for your unique situation.

A corp that only has losses doesn’t really attract a lot of dangerous attention from IRS; so that really isn’t a concern here.  However, there are some other more important issues that you need to evaluate.

For example, I am wondering why you are so anxious to jump into the cost and hassle of setting up a corp right now.  Most small businesses start off as Schedule C sole proprietorships and then evolve into a corp entity as they become more profitable.

Sole proprietorships cost nothing to set up or dissolve; unlike corps in Calif, which have a $800 minimum annual tax.  Losses from Schedule C can also be used to offset other income on your 1040. While losses from S corps can be used to offset other 1040 income, C corp losses can’t do that.

Please consult with a tax pro before you take that expensive leap into a corp.

Good luck.

Kerry Kerstetter

Follow-Up:

Thank you so much for taking the time to answer my email Mr. Kerstetter, especially in these holiday times. I have taken your advice, and will be seeing a tax pro. ASAP to seek some advice in these matters.

Q-1:

Subject: S Corporations

Tax Guru,

I am a Obama supporter but work at a S Corporation.  Needless to say, I am getting hammered for my voting preferences. 

Can you tell me if Obama will destroy S Corporations.  I read he would increase from 35% to 39% on scorps but can not find any evidance that he will not due away with them. 

Any help would be greatly appreciated.

Obama & Scorp supporter.  

A-1:

S corps don’t pay taxes. Their income is reported and taxed on the 1040s of the shareholders.

Since Obama is promising to raise the tax rates for 1040s, the end result will be higher taxes for the shareholders on their S corp income.

I don’t see any push to eliminate S corps because they are often taxed at higher rates than C corps.

I hope this helps you understand.

Kerry Kerstetter

Q-2:

Thank you for your response.

I currently have around 40,000 in stock through our S-corp.  However I have never seen my stock or dividends on my yearly income. 

Our company is roughly 2400 people, employee owned, with 6 "owners", 5 real people and one account (representing the esop balance). 

If I dont pay taxes on my dividends ($5.50 per share last year) until I retire then is S-corp advantagous to C-corp?

Thank you so much for your responses.  I am trying to understand the situation but find it beyond my grasp at this time.

Please advise..

A-2:

It sounds like you have an interest in a tax deferred retirement account. You’re little vague on the dividends you received, but I’m assuming that those were deposited into your share of the retirement account and not actually paid out to you directly.

While the details of retirement plans can vary, the basic concept is that you pay no taxes on any income it earns while your money is inside the plan. When you start to draw it out, you will pay income taxes on your distributions at ordinary income tax rates for the years of the withdrawals. If you are under 59.5 years old when taking distributions, you may also be subject to the additional 10% Federal (+ your state’s) early withdrawal penalties if you don’t meet any of the exceptions for that.

I really don’t see how whether your employer is a C or S corp will make any difference to you in regard to your taxes on your share of this retirement account.

Your retirement account administrator and your personal professional tax advisor should be able to explain how this all works in much more specific detail for your unique situation than I possible could.

Good luck.

Kerry Kerstetter

Q:

Subject:  S corp’s

Hi I just found your site and read about S vs C Corp’s.  We have been an S Corp for years.  Some questions I have is:  money taken out by shareholder ( my wife and I) should that be ledgered under personal income or shareholder loans?  Is that money taxable?  My CPA says it is not taxable.  Why would I ever pay myself in wage form if this is the case.  I see as our profits get up to 65,000 or more maybe we should start a C Corp.  How so you smooth out the money in a C Corp.  I don’t understand.  Maybe I should get a new CPA? 

Thanks

If you’ve been operating an S corp for any period of time and your professional tax advisor hasn’t explained to you all of the details of how cash distributions are treated, it does sound like s/he has dropped the ball.  That all should have been explained to you prior to your even setting up the S corp.

Likewise, if your professional tax advisor isn’t aware of how to effectively utilize a C corp to smooth out your taxable income, it is time to find someone who understands this very basic tool of tax planning.

Good luck.

Kerry Kerstetter

 

Q:

Subject: C- corp tax rates

Is this C-Corporation Income tax rate schedule published on your website for 2007 or 2008?

Thank you for your response

A:

Unlike individual income tax rate brackets, which are adjusted annually for inflation, the corporate tax rates are only adjusted every few decades, if ever, by our rulers in Washington.

The corp rates shown on my website have been in effect for the past several years and will most likely be in effect for several more years.

I hope this helps.

Kerry Kerstetter

Q-1:

Subject: Choosing a fiscal year

Hello Tax Guru,

I was not sure if I can post on your blog, I had a question about Fiscal year and S-Corp. Is there no situation where an S-Corp can have a fiscal year end on June 30th like you suggest for other corporations or am I misunderstanding the S-Corp?

thanks, great blog!

 A-1:

 S corps are required to use the same tax year as their shareholders, which is almost always a calendar (December 31) year.

If income shifting between years is a critical factor, a C corp is an easy way to accomplish this.

Your personal professional tax advisor should be able to help you set up a structure with one or more entities to achieve whatever goal you have.

Good luck.

Kerry Kerstetter

Q-2:

 Kerry,

thanks for the great info. Our challenge is that we are receiving a product order prepayment from the US DOD for $250K and may not have to pay our factory till after Jan 1st. 2009 and we don’t want to pay taxes on the $250K sitting in the bank, what would you do?

Will will apply for S-Corp status with IRS.

thanks for your help!

A-2:

Using a C corp to smooth out that income and have control over the timing of the taxes on it is a very simple task for any experienced professional tax advisor.  You need to start working with one ASAP.

Good luck.

Kerry Kerstetter

Follow-Up:

 Thanks again Kerry!

As has been quite obvious from the never-ending emails I receive, there is no shortage of confusion over the proper business entity to use.  As I have to continually point out, the biggest mistake is when people try to make these choices on their own, without the assistance of professional advisors.  That is nothing short of reckless and is no way to start off a business operation.

However, as I have pointed out, it will save time and fees if business owners will acquaint themselves with the basics of the various business structures before meeting with their professional advisors.  In that vein, I pass along this IRS Fact Sheet that briefly describes the basics of the four most commonly used business entities.

The best bit of info in this Fact Sheet is at the very end:

It may be important to seek advice from business experts and professionals when considering the advantages and disadvantages of a business entity.

As I’ve explained countless times, there is no reference material in existence, on the web or off, that can substitute for the services of a good professional business advisor, who should analyze the pros and cons of the various business entity types in relation to the exact situation at hand.  However, some review of the basics beforehand can save a lot of expensive time with the professional.  I always feel bad about charging clients almost four dollars a minute for explaining the basic concepts of corporations and LLCs, that they can read about on their own. Before I meet with clients to discuss what kind of entity or entities makes sense for a particular situation, I strongly encourage them to read over the materials I have posted on my website.

I just came across some new reference materials on the basics of selecting a business entity from the Intuit company, MyCorporation, which can be downloaded for free.

WMV video “Selecting the Right Business Entity”  showing how to use a decision tree method of selecting an entity.  This is 29.5 minutes long and the file is 21.3 mb in size.

20 page PDF file “Guide to Forming Corporations & LLCs”   File size is 1.8 mb.