Q-1:

Subject: RE: Fiscal Year

Kerry,

I read your online article I have a question with respect to the following paragraph:

Fiscal Year
One of the most useful tools in the tax game arsenal is the ability to shift income between taxable years.  Individuals report their taxable income based on the January 1 to December 31 calendar year.  S corporations are required to also use the calendar fiscal year, allowing no opportunity to shift income between years.  C corporations, however, can end their fiscal year at the end of any month.  The first tax return will almost always be less than a full 12 months, so don’t worry about coordinating it with the incorporation date.  How this saves on taxes is pretty straight forward.  Toward the end of your personal fiscal year (12/31), you bleed off some of your taxable income to your C corp by paying it for something like rent or marketing services.  In January, your corporation can pay it back to you.  Near the end of the corp’s fiscal year, bleed its net profits out by paying yourself This back and forth income shifting can go on for a long time.  Sometimes income is never taxed; or if it is, we make sure that it is taxed at the lowest rate possible (15%).

Specifically,
  
I am a physician, a radiologist to be exact.  I am currently in the military, and I owe 2.5 more years.  In addition to my “day job”, I do moonlighting for various local locum tenens agencies.  I followed the pattern of some other people here, and got hooked up with an accountant here who got me set up in some entities.  I do not know if this is the right way to go for my particular situation.  I am in essence a “sole proprietor” in that it is just me, as a physician, doing this work.  My goals were to provide a liability shield, and tax advantage.

How this is set up is: I have a S-type professional corporation under the auspices of which I take on these local jobs, either on a daily or a weekly basis.  This is strictly a fee-for-service type arrangement.  The accountant also had me set up a traditional C-Corporation as a management entity. His plan is that the money I earn from my moonlighting each month (in the professional S-corp) is paid to the management C-corp.  He made the tax year-end dates for the S-corp 31Dec, but gave the C-corp a 31 Jan end, ostensibly putting the taxes on those earnings off a year.

My question boils down to the legitimacy of shifting my S-corp income to the C-corp to avoid the taxes; doesn’t the IRS flag this arrangement, which I believe is what you are refering to in your article?

Thanks,

A-1:

It sounds like you are working with a good tax advisor, if you believe in using legal means to minimize your tax bites.  That sounds exactly like scenarios I have set up for clients, which I learned from other tax pros before me.  Shifting income in this way isn’t avoiding taxes.  It allows you to control the timing and rate at which you pay taxes on your income. 

As long as all of the transfers and shifting are done properly and consistently, you are not breaking the laws.  IRS would obviously prefer that people just bend over, grab their ankles, and not do such things and just continue to pay them higher and higher taxes every year; but if you do take proper steps, under the guidance of an experienced tax pro, that is your right to do.

Whether taking legal steps to reduce your taxes is an unpatriotic thing to do is something I have been accused of my entire career. 

My guiding philosophy has always been the following 1934 quote from Judge Learned Hand:

“Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”

Good luck.  I hope this helps.

Kerry Kerstetter

Q-2:

Thanks, Kerry, for the quick reply.  I guess what I really meant to ask you is about the part where you say “…In January, your corporation can pay it back to you.  Near the end of the corp’s fiscal year, bleed its net profits out by paying yourself…”

I get the point about bleeding the money out of the S-corp to the C-corp as a “management” fee, but not about how to legally get that money back to the S in January, so that the “shift” can go on. 

One last thing,  is it legitimate in your opinion for me to in fact “shift” 100% of my profits in the S corp to the C corp?  That is what my current CPA is having me do.  I have taken no salary nor distributions from either account.  I have however, repayed to myself the original money I put in to both entities from my personal account to open the business accounts.  I have heard some sources say that this is a no-no, as the IRS my somehow consider this a “second class of stock” and revoke your S-status?

I may be looking for a new CPA… any interest? You obviously know this game quite well.

Thanks,

A-2:

The shifting of income back and forth is a very common technique.  Various methods can be used, such as leases and royalties, or a catch-all category of Business Services, to accomplish full deductibility on the return from which it was paid. 

Having just a one month overlap in the tax year-ends makes it a little tighter time-wise to plan the amounts needed to shift, but it is entirely possible to do.

It’s not always necessary to bleed out 100% of the net profit; but that’s a judgment call made with the assistance of your professional tax advisor, who will need to work with up to date accounting info.  The weak link in this game plan is almost always out of date bookkeeping, making it a shot in the dark in regard to determining how much income needs to be shifted.  The more up to date the books are for all of the entities involved (1040, 1120 and 1120S in your case), the more effective the income shifting will be.

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. 

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

Kerry Kerstetter

Q:

Subject: Corporations

We are a bookkeeping firm run by Enrolled Agents. Can we set-up corporations for our clients and charge them for the service without any type of legal license such as a LDA or Paralegal? Thank you for your help.

A:

There is no quick and easy answer to this because the environment regarding how aggressively the attorneys protect their “turf” varies by state and area of the country. You will need to do some research in your state to see it is safe for non attorneys to provide this service. The easiest way would be to see if there are other non-licensed people already doing this near you and they have been allowed to continue without prosecution from the state bar.

You didn’t say where you are located, but the zealous protectionism demonstrated by some state bars can reach ridiculous levels. A perfect example was in Texas, where Nolo Press was prosecuted for practicing law without a license for merely selling books and software dealing with legal issues. They ended up winning their case, but they had to endure the cost and hassle of defending their position for two years, which is something that you would most likely want to avoid. They have a short summary of this on their website.

Good luck. I hope this helps.

Kerry Kerstetter

Q:

Subject: Timing Question

Hi Kerry- I am an attorney who, although not a trained accountant, does deal with accounting issues from time to time in my work.  My wife has a consulting business that she started with on a full time basis in January of 2006.  She generates about $100K in revenue, and all of this revenue is captured on a 1099-Misc.  Most of her business expenses are reimbursed by the main company for which she contracts.  The only real deductions we can take advantage of are a home office, her computer equipment, and her travel in our car.  In 2006, we paid taxes on all the revenue she generated on our jointly-filed income tax return.  This year, however, I am thinking of creating a corporation for the business, and possibly converting it to S status. If I do so, I have 2 questions:
 
1) If the corporation is created in October 2007, can the revenue that the business generated prior to the entity’s official creation be captured and reported on this year’s tax return?
 
2)  Is there any way that I can amend my 2006 tax filing by retroactively reporting the 2006 revenue as belonging to the corporation?
 
As the father of 2 young kids, I’m just now trying to work through these issues.  Thank you in advance for any assistance you can provide! 

A:

I can give quick answers as to what is possible and what’s not.

If you can get a corp up and running before the end of 2007, it is possible to shift some or all of the 2007 year to date profit over to that corp by paying it for business services that would be deductible on your wife’s 2007 Schedule C and reported  as income on the 1120.  There should be actual payments and you will need to make sure all future income is paid to the corp and the payer doesn’t report it under your wife’s SSN.  If too much income is accidentally reported under her SSN, there is a way to fix that on the Schedule C, which any experienced tax pro can handle for you.

This can’t be done for 2006 income for a couple of very basic reasons.   No payments to the corp were made during 2006 and the corp didn’t even exist in 2006.     

You really need to be working directly with a tax pro to help you and your wife set up whatever entity or entities would be most appropriate for your situation.

Good luck.

Kerry

Corporations vs. LLCs

Types of Ownership Structures

Choosing the Best Ownership Structure for Your Business

Limited Liability Company FAQ

Q:

Greetings Mr. Kerstetter,

 

I just stumbled upon your site the other day.  Thank you for maintaining it, it’s a great resource.

 

I wanted to ask you about your article “Choosing A Fiscal Year“.  In it, you talk about the virtues of choosing a FYE other than 12/31.  You say “once the first 1120 has been filed with IRS, the fiscal year is set in stone.”

 

I was reading on another site about Form 1128 which seems to allow you to petition the IRS for a new FYE.  Can you comment on this?

 

Best,

A:

While you are correct that there is an official form to request a change in an entity’s tax year, the actual use of it is very discriminatory.  Because of the very well known tax savings opportunities in having a non 12/31 year end, IRS will almost always grant a request to change from a year ending in any other month to 12/31; but will almost never grant a request to change from 12/31 to the end of any other month.

I don’t have any official stats on percentages of which tax year changes are granted and denied; but my 32 years of experience in this area have given me complete confidence in my conclusions.  I would welcome any comments from any readers who have had a successful track record of obtaining IRS permission to change from 12/31 tax years  to other months.  I doubt any tax pro can cite such a record because of the well known IRS policy of doing what it can to force as many taxpayers into a calendar tax year as possible.

That is why it is so important to properly select the appropriate tax year with the very first 1120 filed. 

I hope this answers your question. 

Thanks for writing.

Kerry Kerstetter

Q:

Hi Kerry,

 

I’m confused.  My accountant advised me to form an S-corporation citing dividend payments would lower my taxes.  I’m confused about federal tax returns.  As an S-corporation I have to declare all earnings on my 1040 and won’t be able to deduct the corporation expenses?   The way I presently have it structured is I’m paying myself 60% of the corporations earnings, and an additional 40% as nontaxable dividends. 

 

If you have a moment would you please clarify.  Can I write off meals, uniforms, etc.  as a sole owner LLC electing s-corp tax filing statues?

 

Thank you,

A:

You need to be working with your accountant on this matter; not a stranger on the internet.

Your accountant should have explained all of the pros, cons and logistical details when s/he helped you come to the conclusion that an S corp was the proper format for your busyness.  S/he should then be available to help you handle the finances properly for your situation, as well as help you maintain the books and prepare the tax returns.

It sounds like either your accountant abandoned you or you chose the insane path of going it alone.  I’m not sure how you got the idea that business expenses are no longer deductible, but that is not the case, nor is it necessary to bleed out all of the profits from an S corp in the manner which you described.  You are operating under some seriously misguided concepts that no decent professional tax person could possibly have told you; so it appears that you are trying the extremely dangerous task of navigating the tax waters on your own.

You need to either reconnect with your previous accountant and get all of the logistical details worked out or find yourself a new one ASAP before you do any more damage.

Good luck.

Kerry Kerstetter

Q:

Subject: S Corps

If a corp has been using a fiscal year that ends in a month other than December, it will have to change to a 12/31 fiscal year end if it changes to an S status. If the S status is later revoked, you will not be allowed to change from the 12/31 year end.

Regarding the above statement if you have sent in a 2553 for S corp. status with a F/Y/E of 3/31 and it is denied what happens to the years you have functioned at a F/Y/E of 3/31.  Do you have to amend the tax return with a F/Y/E of 12/31 even if it becomes a financial disaster.  The corp. functioned as 3/31 and cleared out the income etc at 3/31 and now at 12/31 there is a lot of net income.  Any recourse?

A:

As I constantly advise, you should be working with an experienced  tax pro before undertaking something as major as changing from a C corp to an S.

From the logistics side, your corp would file regular C corp 1120s for the entire time period until the effective date of the S election as specified in the letter you will receive from IRS.  The income and expenses from the effective date onward will be reported on an S corp 1120S.

 Because of the required change in fiscal year, there will have to be at least one tax return covering less than 12 full months.  Unless the effective date of the election is either January 1 or April 1, it’s more likely that both the final 1120 and the initial 1120S will be for less than 12 months.

Again, an experienced tax pro can give you more specifics on how such a change would affect your business.

Good luck.

Kerry Kerstetter

Q:

Subject:  S vs. C orp

Do you still reccommend an S corp for a 1099 contact sales rep for surgical device sales .I am starting out fresh and will recieve $75k first year and scale up to 200 K by end of year 3.

 

Thanks,

A:

You must have me mistaken with someone else because I have never made any kind of blanket endorsement of the use of S corps.  I always warn that there is no such thing as a one size fits all approach and that you must work with an experienced tax professional in order to determine what is best for your unique circumstances. 

I do have some comparisons of C and S corps on my website, but these are no substitute for the experience and judgment of a tax professional.  Start working with one right away before you head any further in the wrong direction.

Good luck.

Kerry Kerstetter

Q:

Subject: general question

Hi Kerry,

I have a general question pertaining to S-corps and taxes. I came across your website in my search for answers. I’m hopeful you may assist.

I have a S-Corp and the IRS recently requested I send a 1040 form for a previous year.

Must I complete the 1040 form using all of my information from the S-Corp filing – (redundancy) or may I use just my K-1 schedules and fill in the 1040.

The IRS has my S-corp submissions

Thanks Kerry for your thoughts

A:

I don’t mean to pick on you here, but you appear to be a perfect example of getting in over your head by setting up an S corp without knowing how they function tax-wise, as well as trying to handle your taxes without the assistance of a professional tax advisor.

If your S corp’s 1120S was prepared properly, its K-1 should have all of the information that needs to be entered onto the various schedules of your 1040.  There is no need to enter the individual income and expenses items that are shown on the 1120S.

Before you prepare your 1040 for 2004, you should have a professional tax advisor review the 1120S to make sure that doesn’t need to be amended.  S/he should then be used to prepare your 1040 for that year as well.

Good luck.

Kerry Kerstetter