Q-1:

Subject: business tax question

Hi,

Thank you for your article on sub s vs. c corp.  I am a licensed professional in healthcare and have a sub s.  I have a sub s, as years ago when I started it, my profession did not have a license in my state and my attorney at the time advised me to start this type of corp.  I do not remember the specifics.  Here we are 13 years later and several attorney and accountant later.  As I make another accountant change, I am advised to consider starting a c corp.  To keep my sub s to do my business so I do not have to change contracts etc.  To have the sub s provide management services for the c corp, which will really have the clients  have the c corp be profitable and the sub s operate at a loss.  This is a new way of thinking for me.  Is it legal?  It sounds a bit on the edge?

 

Thanks for responding.  Each new person seems to add something and it becomes very confusing.

A-1:

Using both an S and a C corp together has been a very useful tactic for decades for exercising more control over business owners’ taxable income.  Too many people make the mistake of thinking everything has to be all or nothing with everything run through a single entity. Depending on your unique situation, using an assortment of entities can result in huge tax savings, as well as better liability protection from nuisance lawsuits.

Working with a creative professional tax advisor who understands how to properly utilize multiple entities is essential, as is up to date accurate accounting because many of the income shifting decisions depend on knowing how much income you have at any point in time.

Good luck.

Kerry Kerstetter

Q-2:

Thank you for your reply.  Would you indulge me in another question or two?

Your reply certainly confirmed the advice of my new accountatnt.  But, I am still skeptical.  There are so many dishonest people, I am apprehensive!! These are my concersn or things I notice.

This new accountant, John Anderson, does not market himself as a CPA.  His business card says CEO of his consulting company.  When I asked if he was a CPA, he said yes.  I checked AZ licensing, but he is not.  I confronted him and he said he had a PA license.  I checked PA and it expired in ’86.  Is that a big deal?  If you have the info and knowledge, I guess you do not need a license to give advice and or prepare taxes.  I am feeling like his answers are not necessarily honest.  Further, he asked for POA to be able to sign to get c corp and do other things for the company.  I am reluctant to give him that power.  Is that usual?  Finally, he mentioned that under the c corp we could in some way deduct our life insurance premiums.  He discussed the keyman policy or by/sell.  It makes sense to me, but my bother in law who sells life ins in TX is adamant that you cannot deduct life insurance. So, I am confused and apprehensive.

Thanks for your time.

A-2:

Anyone you work with should be completely open and honest about the status of his/her licensing.  I’m confused as to which PA you are referring to.  Do you mean licensed as a CPA in Pennsylvania or licensed as a Public Accountant, which is a designation similar to CPA that is rarely seen any more?

While CPAs, attorneys and EAs (enrolled Agents) are automatically eligible to prepare tax returns, each state has its own rules regarding the special licensing of others.

Asking for a power of attorney up front to submit incorporation papers on your behalf does sound very unusual and is not something I have ever requested from any clients, nor would I advise you to do.  While the amount of personal involvement you choose to have in the business transactions is up to you, I would be very careful of delegating too many things to other people.  There are too many things that could go wrong.

There are so many varieties of life insurance policies and ways in which to handle them that there is no easy answer in regard to the deductibility of premiums or whether company paid premiums are taxable as income to the beneficiaries.  There are ways by which to have the ownership of the policy vested in a special trust or in the employer’s name that may be useful.  You need to work with an experienced advisor to see if there is a way to structure things so as to accomplish your specific goals.

No offense to your brother in law, but the claim that life insurance premiums are never deductible is wrong.  There are various occasions when they are.  For example, one that I encounter quite often is when a lender requires a life insurance policy as a condition of making a loan.  For decades, I have been showing those premiums as deductions on client tax returns, with descriptions that they are required by the lenders. IRS has never had any problems with any of them.

I hope this helps.

Good luck.

Kerry Kerstetter

Q:

Subject:  Double taxation?

Kerry,

Thanks very much for your informative and enjoyable blog.

I often hear the line that C corporations are a bad choice because of the double taxation issue. I know you have explained before that there are many ways to avoid double taxation.  But I have tried to figure out why “double taxation” is really worse than the alternative.

Let me explain my thinking. As I understand it, the first $50,000 in income for a C corporation is taxed at 15%, and any dividend that would be paid to shareholders is also taxed at 15% (maximum). Combined, that is a 30% tax rate.  This seems like a bargain compared to the corporation paying a salary:  The individual would likely pay a 28% tax rate on the salary (assuming the individual has already reached the 28% bracket from other income), and then would pay an additional 15.3% FICA tax (half paid by the corporation), for a total federal tax rate of 43.3%.  Since 43.3% is more than 30%, isn’t “double taxation” actually the preferred outcome here, at least for $50,000 worth of corporate income?

Thanks,

A:

I’m too busy right now to go into too much detail.

However, you may have missed the point that I am not a fan of using payroll as a means of shifting income from the corp to the 1040 because of the payroll taxes.  We use unearned income, such as interest, rents and royalties, which have no payroll taxes associated with them; just normal income tax.

By properly shifting income back and forth, we have been able to very easily achieve a maximum Federal income tax of just 15% overall; not the 30% under your double taxed scenario.

A good tax advisor, along with accurate up to date QuickBooks data, should be able to help you achieve this.

Good luck.

Kerry Kerstetter

Q:

Subject:  Does your information on C corporation vs. S corps apply to Personal Services providers?

Hi,

I’ve been reading a lot of your pages and I’m thankful for all of the great info. I even purchased a NOLO book (‘Deduct it!’). However, I’ve talked to 3 accountants, in my search for one to help us with our new company and not one has agreed with our decision to create a C corp. For the reasons you said most CPA’s steer clients wrong, the double taxation and extra paperwork. One even went so far to say that everything that’s deductible in a C-corp is deductible in an S-corp. and that I was paying the max. tax rate because we are a personal services corp.
The hubby will be a sub-contractor for a gov’t project providing consulting services, so would that make a difference?
Thanks for any help! If you don’t have time, a book recommendation that would have the answer is perfect, too!

A:

There are far too many options to consider and possible scenarios that can be used to achieve your goals for me to even begin giving you specific advice via this medium.  You will need to work directly with an experienced tax pro who can analyze your unique circumstances.

In regard to the problem with conflicting advice from different tax pros you speak with, I would ignore anything from anyone who proposes any strategy without asking you a ton of probing questions first.  Anyone who relies on “one size fits all” solutions is not competent to work with.

In addition, any recommendations should be accompanied with a reasoned and complete explanation of the specific reasons why that particular approach is best for your unique circumstances and why the other possible alternatives are not.  Any tax pro who cannot defend his/her recommendations properly should be avoided. Any tax pro giving any indication of reaching a conclusion for your situation without thoroughly evaluating all of your unique circumstances should also be avoided.

I wish I could be more help; but I already have too many clients to take care of properly; so we are still trimming back on the difficult clients and are not accepting any new ones at this time.

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:

Subject: C Corp

Hi Kerry:

I just read your article on the web as I am researching what to do. Here is my situation I am withdrawing funds from my old 401k to invest in a franchise.  The company Benetrends and or Guidant indicate that they would form a C corp for me which would buy stock in the new company.

Some people have brought up the “double taxation” issue with C corps. The cash flow from one franchise is about 25 K on a 60-85k Invetsmnent. The other location which I might get is is a 15k cash flow based on a 45-55k investment.

What would be your advice?  I plan  put in some amount into 401 k with the new corporation to reduce taxes but I need to withraw funds ( that wont be taxed again on my tax return)  to reduce debt elsewhere,

Do you know of accountants in the dallas area who would be able to keep the books for my new corp?

Thanks in advance for your time.

A:

There are so many very easy ways to pull money out of a C corp in a tax deductible manner that any good tax consultant can help you avoid any double taxation.

There are far too many options to consider and possible scenarios that can be used to achieve your goals for me to even begin giving you specific advice via this medium.  You will need to work directly with an experienced tax pro who can analyze your unique circumstances.

I wish I could be more help; but I already have too many clients to take care of properly; so we are still trimming back on the difficult clients and are not accepting any new ones at this time.

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:

Subject:  C corp to S corp

Hello,

 

I am an investor/shareholder in a California “C” Corp.  The President of the corporation just informed me that he was going to convert to “S” Corp.  He advised me the stock certificate (issued under the C corp) which is in the name of my living trust would have to be reissued into the name of an individual(s).

 

Why would one change the status of the corporation.  Does this work in my (the shareholder’s) benefit?  What about the inability to hold this asset in my trust.

 

After reading your article…I’m uncertain of why he would make this change.  Sounds a bit fishy.

 

I have a call into my CPA…but it is tax time and I just wanted a quick review if you have time.

 

Thanks a bunch,

A:

There must be more to this story than you’ve recounted here because some of it is literally impossible to do.

Specifically, one person can’t unilaterally change a C  corp to an S unless he is the sole 100% owner.  The election form requires the signed consent by every single stockholder because this election obligates each stockholder to report his/her share of the corporate income on his/her own 1040. How is the president of a corp of which you are part owner forcing you to sign the election form without your being able to analyze its impact on your unique situation?

After discussing the pros and cons of making the S election with your own personal professional tax advisor, you can decide whether to go along with it or not.  I have no way of knowing if it makes sense for you or not.  There are too many issues to consider.

Assuming the election makes sense for you and you are going to sign the  IRS form, the next issue seems to be whether your shares can be titled in the name of your living trust.  This depends on exactly what kind of trust you have.  If it’s a normal revocable living trust, which is generally considered to be a disregarded entity for tax purposes while you are alive, it shouldn’t make any difference whether the shares are in your own personal name or the name of your living trust because both will be using your SSN for identification purposes.

If it is a different kind of trust, especially one that has its own FEIN and files its own 1041 tax returns, there are limits and restrictions on S corp ownership.  There are also special kinds of trusts that can own S corp stock if that is appropriate for your situation.  Your personal professional tax advisor can help you with that issue.

Good luck.  I hope this helps.

Kerry Kerstetter

Q:

Subject:  minimizing overall tax liabilities among related entities

Kerry,

I am a CPA practicing in Texas and I am interested in an issue you have discussed on your blog.  It involves the legal shifting of income and deductions between at least three (or more) entities, say a C corp with a fiscal year-end, an S corp with a calendar year-end, and an individual owner of both corporations.  I understand the why, the timing, and the benefits of the shifting.  My philosophy in dealing with clients and the IRS is similar to yours.  I am not afraid of taking an aggressive position on my clients’ tax returns, even in light of the changes to the Circular 230 rules and the IRC Section 6694 penalty provisions.  But the hesitancy in using this strategy is my possible inability to have enough solid reasons to convince the IRS that there is a valid business purpose for the arrangement.  I am a bit nervous about the IRS asserting that the entire arrangement is a sham thereby collapsing the two corporations into one and destroying my tax planning.  It would be helpful if you could reveal at least a portion of your strategy for developing the rationale for using this method of tax planning.  If that would be too intrusive and not something you would like to divulge, would I get some of my answers by using TAX Coach?  At your recommendation, I subscribed to their service but have not run an analysis for a client yet.  How successful have you been in defending your clients who are using this tax planning strategy when they were audited? 

 

Thank you, have a good tax season, and I hope you won’t tell me “I really should be working with my own professional advisor on this matter” (ha).

   

A:

As you’ll see in an upcoming post, there seems to be a lot of self censoring by tax pros whose imaginations have obviously gone wild about encountering the nastiest IRS auditors who will disallow anything that could have possibly saved the clients money on their taxes.  The result is a fear to recommend very basic tax savings strategies, such as multiple entities, and thus forcing their clients to pay more in taxes.

Having encountered every possible kind of IRS auditor there is over the past 30+ years, from real hard-asses to wimpy ones who literally allowed me to have my own way with everything, this fear is crazy and smells of professional paranoia.

As long as a valid business connection is there, such as leases, commissions, royalties, salaries, etc., and the amounts being passed between the owners and the entities are consistent, IRS will have to accept the figures.

I have had cases where IRS auditors have seen monies being passed around different entities, and they only cared that all entities were using the Cash basis of accounting and that the amounts were consistent.

As part of the Clinton Family’s attack on me for being critical of them in my newsletters, IRS came after Sherry and my personal tax returns and had no problems with the monies we shuffle around our different corps when I showed the figures were consistently treated on our 1040 and the 1120s.

About four or five years ago, a client’s 1040 was selected for audit based on huge interest expense deductions. When the auditor saw a lot of money passing back and forth among the client and his several wholly owned C and S corps, all he asked me was whether the corps were all on the Cash basis.  When I explained that they were all using the Cash basis the auditor said that was good and he wouldn’t need to look at the books for any of the corps.  He said that if any of the corps had been on the Accrual basis, he would have had to perform a full blown audit on the corp as well.

Using corps to shift money around to minimize the overall tax burden has been around for longer than I have and will always be a perfectly valid technique.  I guess I was lucky in the fact that one of the CPAs I worked for at the beginning of my career was using this strategy for his own and his clients’ finances; so I got an early start with it and have been working with it ever since.  It is a shame that there are too many tax pros today who are afraid of it.

While I haven’t used them for any of my clients, TaxCoach does have some nice reports that you can generate to show clients how using corps can work to reduce their overall tax burden.

Good luck.  I hope this helps.

Kerry Kerstetter

Follow-Up:

Kerry,
Thanks very much for your reply.  It was just what I needed to hear in order to boost my confidence enough to begin recommending this strategy to my clients.

Q:

Subject: article

Thank you very much for your insightful article on S vs. C Corporations. I have a quick question I am hoping you can help me answer. You mention the possibility of double taxation with a C Corp on paying out dividends, what about paying myself commissions? Would that be similar to paying myself a salary? I have a small business, myself and sub-agents that I 1099 each year.

Please advise. Your response is greatly appreciated.

Thank you,

A:

You absolutely must be working directly with an experienced professional tax advisor on matters such as this.

Avoiding double taxation is very easy and is accomplished by shifting income from the C corp to yourself as an individual via expenses that are deductible from the corp’s taxable income and are then taxable income on your 1040.

The most frequently used types of corp expenses for this are W-2 salaries, 1099 commissions, rents, royalties and interest payments. However, these are not equal in the overall tax burden they create because some of these are also subject to payroll taxes, while other ones are not.

That is why you need to work with a tax pro who can look at the big picture to help you achieve your goals, while minimizing the overall tax bite.

Good luck.

Kerry Kerstetter

Q:

Subject: Confusion…

Kerry – Thanks for having your webpage! I found it very interesting reading. Unfortunately, I’m still wondering if I’m doing things correctly.

Suspect some background would be good:

I’m divorced, and paying child support (for another 5-6 years), and alimony. My wife had legal access to my 1040’s until now (that has ended in 2008 without a court order).

I’ve remarried to a legal resident, but non-US citizen (think thats relevant to S-Corp designation?). We formed a C-Corp in late 2006 to deal with single family home rentals we were interested in doing. Since then, we have grown to 6 homes in the area. Someday we would like to own 10, but no more. All are mortgaged in my name, since personal mortgage rates are WAY lower than Corporate mortgages. The C-Corp is the public interface that manages the property, accepts rental payments, pays the mortgages, reimburses travel expenses, etc.

At 10 homes, this company MAY generate $5000/month in profits in perhaps 10 years – and will be losing money or barely breaking even for some time. It was our plan to simply pay my wife a salary to drain that income from the company.

I am wondering if I should convert this C-Corp into an S-Corp, or LLC, in order to simplify accounting. e.g. Turbo-Tax handles rental properties well… and Intuits Rental Property Manager can feed Turbo-Tax directly. This would reduce (eliminate) my dependence on a local CPA that if a MAJOR expense ($150/hr and he loves to try and verify every transaction that occurs in the year, running up the total bill).

Any suggestions?

A:

There are far too many options to consider and possible scenarios that can be used to achieve your goals for me to even begin giving you specific advice via this medium.  You will need to work directly with an experienced tax pro who can analyze your unique circumstances.

I wish I could be more help; but I already have too many clients to take care of properly; so we are still trimming back on the difficult clients and are not accepting any new ones at this time.

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 do want to caution you from making these kinds of decisions based on your tax and accounting fees.  That is a very short-sighted approach to this kind of thing.  For example, I have plenty of clients with corporations whose annual charges are at least a thousand dollars more each year than they would be if we only had to prepare an annual 1040. However, I know for a fact that in almost every one of those cases, the proper use of their corporations allows them to reduce their overall tax bill by anywhere from $10,000 to as much as $50,000 each year.

I have long advised that there are what I call nuisance factors in having to keep separate books and file separate tax returns for corporations.  Only you can decide how much those factors are worth in dollars and cents.  However, for most people, spending a little extra time and $1,000 more in professional fees in order to save well more than $10,000 in taxes each year makes the nuisance factor seem quite affordable.

As I’ve constantly warned, there is no one size fits all in terms of the proper entities to use.  C corps do have a lot of tax savings opportunities if you work with an experienced tax professional.  Either way, if you were to use an S corp or an LLC, you would still need to keep separate books and file special income tax returns for them; so I don’t see how that should be much of a factor in your decision process.

Also, as I’ve warned for decades, if you think any tax software, whether it’s the consumer oriented TurboTax or the extremely expensive professional Lacerte software that I use, can take the place of a good tax pro, you are dangerously mistaken.  Nowhere is the adage of garbage in, garbage out more appropriate than with tax software.  Saving a few hundred dollars by trying to prepare your own tax returns is insane. Any good tax person will save you much more in taxes than his/her fee, as well as give you more protection against screwing things up on your own.

I’m sorry to be so blunt; but these points needed to be made.

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

Kerry Kerstetter

Follow-Up:

Appreciated Kerry - I'll go surf your section on selecting a tax preparer.

Thanks,

I actually sent the very same answer to the following two emails that came in within a few days of each other from different people.

Q-1:

Subject: Converting from an S to a C Corporation

My S corp is located in the state of Tennessee and I would like to change to a C corp.  What specific tax form do I use to make this change?

Q-2:

After our fiscal year end (Aug 31, 2007), we sent a request to the IRS to change from C to S Corp.

 

We have since realized that this is probably not a good idea.

 

Is it possible to void the request and not file a short return?

 

Any help will be greatly appreciated.

A:

As I’ve mentioned on several occasions, nothing related to dealing with an S corp is a do it yourself task.  This covers the decisions to become an S corp, as well as to revoke the S election. All of those processes need to be handled with the assistance of an experienced professional tax advisor, who can thoroughly analyze your business’s current and future situations.

Needless to say, the actual mechanics of revoking the S election, if that is considered to be the appropriate course of action, are also not something you can do on your own. 

I have lost track of the number of times I have heard about people, hoping to save a few dollars in consulting fees, making what I can plainly see are bone-headed decisions to either choose to be classified as an S corp or to revoke an S election and then have to deal with the restrictions that entails, such as the use of the much more expensive calendar tax year. 

Again, as I have explained on countless occasions, it is frequently a much better plan to simply start up a brand new C corp than to try to convert an existing S corp back to a C.  That decision also needs to be made with the assistance of an experienced tax advisor.

This is obviously not the answer you were expecting; but it’s plain from your question that you are already in dangerous territory by attempting to navigate the corporate tax environment without professional assistance. I hope I’ve made the point about how foolish that is.

Good luck.

Kerry Kerstetter