Q-1:

Subject: Shifting money between companies

 

Dear Kerry,

 

On your website you've talked about the merits of owning multiple corporations with different fiscal years, one of them being the ability to shift money back and forth to reduce/postpone taxes.

 

I had a CA S-corp, and based on your advice I set up an OR C-corp last year, with fiscal year end on Jun 30. I intend to use this corporation for other businesses, but I also wanted to have the flexibility to shift money between the 2 companies if needed. 

 

However, I spoke with my new accountant today, and he suggested that any money transfers (by invoicing of course) between such companies would be considered "related party" by IRS, therefore not be deductible, be borderline (maybe flat-out) illegal, would raise immediate flags, and very likely result in penalties. 

 

What is your advice? Should I look for another accountant? 

 

Thanks very much,

A-1:

It's obvious that you need to find a different professional tax advisor; one with some real world experience shifting income between entities.

Income shifting is not illegal and has been a standard business tactic for literally centuries.  As long as the amounts are reasonable for what they represent, and are treated consistently by both sides (payee and payor), IRS will accept the numbers. 

A few years ago I had an IRS auditor tell me that as long as both sides are using the same method of accounting (cash or accrual), they won't even bother looking at the related party transactions.  If they are using different methods, then the auditors will look to see if there is any artificial manipulation going on.  That's why I make sure all of our clients and their related entities are using the cash basis, and IRS has never had any problems with any of the income shifting we have been doing for over 30 years.

For example, back before I sold off my Bay Area practice, I had some clients for whom we had set up a Calif corp and a Washington State corp. Each tax year, we made sure to shift all of the corp profits out of the high tax PRC into tax free Washington.  This is frequently done with Nevada corps as well.

Anybody who claims that income shifting between related entities is illegal needs some more education before s/he is safe to consult with actual real world clients.  When interviewing potential tax pros to use, make sure to cover this topic up front and only choose a person who can give you some examples of how this tactic can be used in your situation.

Good luck.

Kerry Kerstetter

Q-2:

Hi Kerry,

 

Thank you. I appreciate your detailed response. You've mentioned that you had your clients use the cash method in all their accounts. Likewise, would it be okay to use the accrual method instead, as long as it's consistent across all companies. Are there any restrictions on that specific to S-corps?

 

Thank you.

A-2:

You'll need to work on this with your own personal experienced professional tax advisor.

Personally, I'm genially against using the accrual method because we do a lot of income shifting between individuals and their corporations, and individuals are always on the cash basis. 

The conversation with the IRS auditor I mentioned previously was during an examination of a high income individual's 1040.  When the auditor asked about payments between him and his corporations, he specifically said that because the corps were on the cash basis, he would skip looking at them; but if they had been on the accrual, he would have had to examine the corporations as well.

Good luck.

Kerry

Follow-Up:

Okay, thank you very much for your time and advice.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/10/2007 08:21:00 PM Send this post: