Q:

I have just finished reading your comparison on the S vs C corporations. I currently have a $ 12 million computer supply business that is a C corporation. I have repeatedly been told by attorneys and others that I should be an S corp because of the large bonus that I take at year end.  They say that the IRS could say that this is a dividend. I don't understand because as it is now I pay full  taxes on the bonus also. After reading your comparison, I believe I should stay C. for the reasons you explained. Am I missing the point here? Thank you for your very enlightening article.

A:

I would say that keeping at least one C corp would have more tax saving opportunity than running all of your income through an S corp.  Just having an S corp piles all of your income into just the individual income tax brackets, missing the chance to use the lower C corp brackets.

How to pull the income out of the corp with the lowest tax hit is always an adversarial game between you and the money hungry IRS.  IRS would love for you to consider the payments nondeductible corporate dividends because that would allow them to actually tax the same income twice, once on the 1120 and again on your 1040.

The best plan is to use a combination of deductible corporate payments, such as wages, interest, leases, and royalties, in order to avoid the double taxation. 

Fringe benefits paid by the corp and which are tax free to the employees, are also much more lucrative with C corps than with S.

The term "reasonable" is subjective and the cause of skirmishes with IRS, which obviously wants that number as low as possible in order to classify everything above that as double taxed dividends.  Good documentation of how your numbers are calculated, as well as good records, and consistent treatment between the 1120 and 1040, are the best was for you and your tax advisor to make this immune to IRS challenge. 

Having both the corp and your personal taxes use the cash basis of accounting is also an important aspect to avoiding IRS problems.  If the corp uses the accrual method, that is so open to abuse that IRS auditors will have a field day  ripping apart the accrual methods used.     

Of course, when a business become large, I am a big believer in not putting all of your eggs in one basket and using multiple entities at the same and in staggered levels of ownership to help reduce your tax burdens, as well as the inevitable liability and lawsuit exposure that success brings.  These can include an assortment of C and S corps, as well as LLCs and trusts.

These are a just a few ideas I had, as I unwind from the April 15 crunch.

Good luck.

Kerry Kerstetter 

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/17/2005 07:18:00 PM Send this post: