By Karl L. Fava, CPA
as appeared in
the January, 1996 edition of Crains Business – Detroit
As a business owner, look at the 1996 tax liability you just figured for your business. Do you see room for improvement?
Yes, we thought so.
And if you want, the tax liability you compute next January to be less than the one you just finished computing, the time to think about how is now.
Every business has needs unique to it, but many options are available for most to consider than can result in tax savings in 1997.
Some of the options we most often recommend include:
Filing for sub-“S” corporation status. Under Sub-S status, the owner of a business can be taxed at individual income-tax rates rather than at corporate rates.
True, individual rates are now higher than they were a few years ago and may be higher than corporate rates, but in most cases, paying the single, higher rate still beats getting taxed twice, which is what happens when you pay the corporate rate and distribute corporate income as a dividend.
Additionally, a significant advantage would occur at the time an owner sells his or her business via an asset sale and, in effect, is again taxed only once on the transaction, instead of twice, which happens with a “C” corporation.
This is important to anyone considering succession planning, either by selling the company or passing it on to a family member.
Not all companies are eligible for Sub-S status. Those with more than 35 shareholders or those with even one foreign shareholder cannot become Sub-S. Those whose fiscal years do not end Dec. 31 have to adjust to coincide with the end of the tax year for individuals, unless an additional election is made by the Sub-S Corporation.
For those who are eligible and interested, there is no time to waste. Companies wising to elect Sub-S status must do so by March 15 or by the 15th day of the third month of their fiscal year.
Personal ownership of assets. Owners of a small business may want to consider owning the company’s assets – the real estate and even personal property, like manufacturing equipment, trucks and furniture – then leasing them back to the company.
What’s the point? The rent your company pays you is not subject to the usual FICA taxes, 401 (k) contribution limits and single-business-tax add-back rules; so you’re better off accumulating the money as personal income than as part of your company’s revenue. The transactions must be structured to conform to all the passive-activity rules.
Tax-minded investments. Certain investment options may offer you the best possible after-tax treatment.
If you own your company, converting some personal income into business investments that would realize capital gains and would be taxed at the maximum capital-gains rate of 28 percent (and possibly lower, if Congress follows through on talk of reducing it) may allow you to avoid paying the highest rate of 39.6 percent on ordinary income for individuals.
As a business owner, you may have the opportunity to use your money to generate capital. Why not do so, rather than simply pay the money to yourself as salary and pay a 50 percent higher tax on it. Securities, real estate and other properties held for more than one year will generate long-term capital gains rather than ordinary income.
You also may want to shift income to lower-tax-bracket individuals such as children, grandchildren and aging parents.
As the business owner, you have the opportunity to control your salary and the salaries of your employees. Obviously, any family members receiving salaries must be employees of the business performing legitimate functions.
Pension-and benefit-related strategies. Many ways exist to use your approach to pensions and benefits to help minimize tax liability.
For example, many companies use the split-dollar life insurance strategy. A business owner looking to get the value of his lifelong investment out of his business may use split-dollar life to achieve this. Split-dollar life insurance also can provide a form of a pension and potentially can be used for estate planning.
Under such a plan, a company funds the majority of a life-insurance program, essentially an expense of the business. Therefore, the owner is establishing a retirement fund or a vehicle for a buy-sell agreement, while the business is incurring a current tax deduction.
Charitable contributions of disposable inventory. What are your plans for your obsolete or “no use” inventory? If you put it in the trash bin, you will be able to deduct only what you paid for it.
If you donate it to charity, you will be able to deduct its estimated value at the time you donated it, which may be higher. Which would you rather do?
It may be too late to do much about your 2002 tax liability, but it is not too early to be thinking about and planning tax strategies for 1996. This is the time to figure out how you can position yourself to be at the best advantage come January.
