25 BASIC BUSINESS TAX PLANNING STRATEGIES

CHOOSE THE OPTIMAL BUSINESS ENTITY STRUCTURE

1. Avoid the double taxation applicable to the earnings of a C-corporation (C-Corp) by electing S-corporation (S-Corp) status or converting to a limited liability company (LLC).

2. Avoid flow-through tax reporting (such as Schedule C or K-1) that subjects 100% of allocable business income to payroll taxes.

3. Take advantage of a C-Corp’s ability to reinvest earnings in the business at a lower top marginal tax rate (21%) than the rate applicable to individuals (37%) under the flow- through taxation of a S-Corp/LLC.

4. Take advantage of a C-Corp’s ability to provide tax-deductible benefits to shareholders with more than a 2% interest, which are restricted in an S-Corp.

5. Use a C-Corp and an S-Corp/LLC together, in order to:

a. combine the advantages of both forms;

b. take advantage of the separate set of graduated income tax brackets available in both forms; and

c. improve asset protection.

TAKE ADVANTAGE OF DIFFERING TAX RATE SCHEDULES

6. Take advantage of the lower corporate tax rate (21%) by allocating taxable income to a C-Corp. (For example, allocating $100,000 of earnings to a C-Corp can produce $16,000 in annual income tax saving because the 21% flat corporate rate represents a 16% savings from the 37% top individual rate ($100,000 x 16% = $16,000).

7. Take advantage of differing fiscal years and accounting methods between entities (and the owner) to create income deferral opportunities.

8. Lower the owner’s salary to reduce payroll taxes, while making up the difference in the form of distributions from a S-Corp/LLC.

9. Take advantage of corporate tax deductions from which shareholders can benefit on a tax-free basis, such as qualified retirement plans, health plans, group term life insurance, cafeteria plans, non-taxable fringe benefits, meal reimbursement plans and the 14-day rental of personal residence (under IRS Sec. 280A).

10. Transfer shares of an S-Corp/LLC to children active in the business, to take advantage of a second set of graduated income tax brackets. (The top marginal rate for parents is 37%, while the bottom marginal rate for children is 10%).

11. Transfer shares of an S-Corp/LLC to a tax-exempt Employee Stock Ownership Plan (ESOP Trust) to escape all taxation of the allocable flow-through earnings.

12. Refinance existing debt through an ESOP Trust (transfer a minority interest to the trust in exchange for the trust assuming the existing corporate debt), to get a deduction for both principal and interest on the debt.

13. Appropriate the excess accumulated earnings of a C-Corp for a valid business purpose, to avoid the accumulated earnings tax. (If a corporation allows its earnings to accumulate beyond the reasonable needs of the business, it may be subject to an accumulated earnings tax. This tax is set at 20% and is designed to prevent corporations from hoarding profits to avoid shareholder income tax.)

SPONSOR TAX-FAVORED EMPLOYEE BENEFIT OR RETIREMENT PLANS

14. Implement qualified plans that provide a tax-free benefit to employees and a tax-deduction to the company.

15. Maximize pre-tax retirement savings through various qualified retirement plans which allow greater deferrals of pre-tax income than traditional IRAs.

16. Create an ESOP Trust, for the benefit of the company’s employees, and transfer a minority interest to the trust on a tax-favored basis. This can provide employees with a share of corporate earnings, without the owner necessarily having to sacrifice managerial control.

ADD TAX SAVINGS TO A BUSINESS SUCCESSION PLAN

17. Structure buy-sell agreements as cross-purchases, to allow surviving shareholders to receive a stepped-up basis for any future transfer of their interests. (A stepped-up basis is only available in a stock redemption on the death of the shareholder under IRC Sec.1014).

18. Fund buy-sell agreements with life insurance policies, to provide liquidity without setting aside cash that may otherwise be needed to operate or expand the business.

19. Use an ESOP Trust to create a market for the owner’s closely-held stock and diversify the owner’s net worth on a tax-deferred basis by selling a minority interest in the closely-held corporation to the ESOP trust.

20. Gift stock shares to children active in the business or bonus shares to key employees.

PLAN TO REDUCE ESTATE TAXES

21. Each spouse should devise property directly to descendants, or to a credit shelter trust, rather than passing 100% of the estate to the surviving spouse, to avoid wasting either spouse’s unified credit from estate taxes (under IRC Sec. 2010).

22. Create an irrevocable life insurance trust to receive ownership and proceeds of an insurance policy, to prevent the proceeds from entering the spouse’s estate.

23. Take advantage of the annual $18,000 per donee gift tax exclusion ($36,000 with spouse), to remove property from the taxable estate.

FINANCE EDUCATION WITH TAX SAVINGS

24. Pay a salary to a child attending college in order to take advantage of dramatic tax rate reductions attributable to their separate graduated tax rates, IRA deduction, personal exemption, standard deduction and education credits.

25. Contribute any after-tax amount to a 529 college savings plan, to allow the earnings to grow tax-free and withdrawals for qualified expenses to be made tax-free.