Not All or Nothing

As I have been advising for decades, there is no quicker way to reduce one's tax burden than by using a C corporation. However, too many people shoot themselves in the foot by not consulting with a professional advisor who understands how to most effectively utilize the corporation. I have touched on several of the most common mistakes made over the past few years and will continue to comment on others.

Most corporations are an evolution from a Schedule C sole proprietorship. Moving to a C corp allows huge savings in both income and Self Employment taxes, as well as allows for the corp to pay for many tax free benefits for the owners, such as medical, childcare, travel and education costs. Most people believe that once the corp is established, the Schedule C business should be terminated. That's not a good idea for a number of reasons, such as family employees and self employed retirement accounts.

One of the big tax breaks that many people overlook is the special exemption that there is for employing their kids in their business. Dependent children under 18 are statutorily exempt from all of the payroll taxes that are normally due for unrelated employees. Rather than paying kids a non-deductible allowance, it is a much more tax efficient means to pay them family wages for helping out in the business. How much you pay is up to you. Many people pay their kids up to the amount of the standard deduction ($4,750 for 2003) so that they (the kids) don't have to file income tax returns. However, I have seen plenty of cases where teenagers are paid $20,000 or more per year for working in their parents' businesses. While the kids obviously have to file tax returns and pay tax on this, they are usually in a much lower tax bracket than their parents. Income shifting in this manner has been around much longer than I have; but can still save some serious money.

The reason that it's a good idea to keep at least one Sch. C going in addition to the C corp is to be able to channel some tax free family wages for your kids. The corp pays your Sch. C business some money for generic services. Your Sch. C business then pays your kids for helping out. It's a wash. Corporations aren't human and thus can't have family employees, so the only way to avoid the payroll taxes on wages for your kids is to run them through your Sch. C. What you call the Sch. C business isn't really important. It should just be whatever will allow you to deposit the check from your corp into your personal bank account. Your corp should also report those payments to you on a 1099-MISC.

Another common mistake I have seen is for people to bleed out all of the profits from their corporations by paying all of the income out to themselves. This defeats the benefit of smoothing out income between the 1040 tax brackets and the 1120 brackets. With the punitive tax structure in this country, the worst thing is to have all income show up on one tax return, 1120 or 1040. With accurate up to date books, as well as a different fiscal year for the C corp, it is very easy to smooth income out so that neither the 1040 nor 1120 goes over the 15% Federal tax bracket.

KMK
- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 2/02/2003 02:49:00 PM Send this post: