Great Tax-Saving Idea for the Family BusinessAugust 1, 2008
Most closely held businesses are S corporations. Almost all profitable small businesses should be S corporations (pay no tax), as opposed to a tax-paying C corporations. Yet over the years at my tax-planning seminars, one of my standard lines was, “Every small business owner is entitled to one good dog and one good C corporation.” I meant it then, and now.
Here’s the corporate setup we usually recommend to profitable family businesses: Your operating company should be an S corporation (Success Co.), although an LLC is acceptable. A new C corporation (Newco) should be created.
Here’s why. Newco would be a regular or C corporation for federal income-tax purposes. Its business purpose would be to provide sales, marketing and administrative services to Success Co. On a regular basis, Newco will receive payment for its services. The compensation that Success Co. pays is deductible by it and is income to Newco. Among the tax benefits that Newco could provide to the owner and other selected employees:
1) Qualified retirement plan benefits—Newco would adopt a qualified retirement plan, typically a 401(k) plan or a profit-sharing plan, that allows significant contributions for the benefit of its few employees (usually the owner of Success Co. and family members).
2) Health care insurance—Newco can pay for and deduct 100 percent of the health insurance premiums and any uninsured medical or dental expenses that the employees, spouses and dependents incur. The benefits are tax-free to the employees.
3) Entertainment expenses—Newco, as a C corporation, is taxed at the rate of 15 percent on the first $50,000 of taxable income. Under current tax laws only 50 percent of entertainment expenses can be deducted. The remaining 50 percent is essentially paid out of after-tax dollars. Assume that Success Co. is in the highest tax bracket (35 percent). When these nondeductible expenses are paid by Newco, they are paid with 85 percent after-tax dollars rather than 65 percent (Success Co.) after-tax dollars.
4) Long-term care—Newco could buy long-term care insurance for each of its employees and spouses and deduct 100 percent of the cost, while the employees receive the entire benefit tax free.
None of the benefits offered by Newco to its hand-picked employees are required under the tax law to be offered to any employees of Success Co. Now you have found an easy to avoid discrimination rules that apply to Success Co. (and all closely held businesses).
If Success Co. does business in more than one state, this Newco strategy easily can be set up to incur income tax only in the state with the lowest tax rate. If you (the owner) winter in a no-income tax state, such as Florida, then this strategy eliminates all of the income-tax on your salary from Success Co.
What most business owners don’t know is that the to beat the IRS legally is to have two plans make up your estate plan: the traditional will and trust, and a lifetime plan (when done properly, the IRS is out of the estate-tax game).
The Newco strategy outlined is just one of the many strategies we use when doing the lifetime portion of your estate plan. The nice part of the Newco strategy is that it is easy to start and maintain and is very flexible. If you have any questions, call me at 847/674-5295. MF
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