The first news item was about the latest rage in large company tax planning: “tax inversions.” U.S. companies seek to sidestep U.S. corporate taxes by relocating offshore through foreign mergers. The most recent example is the proposed Medtronic/Covidien merger. Even though Covidien has headquarters in the U.S., officially it is located in Ireland where the top marginal tax bracket is 10% lower than in the U.S. Apparently Medtronic hopes to save taxes by merging with an Ireland-based company.
The second news item relates to an ongoing scandal where the IRS is accused of targeting certain not-for-profit organizations because of their political leanings. The IRS announced this month that it can’t find two years of emails from Lois Lerner (the former head of the troubled not-for-profit tax division) to the Departments of Justice or Treasury. An agency spokesman blames a computer crash.
These kinds of stories raise the ire of small business owners. It sometimes just doesn’t feel fair. The big guys play “name that country” and the tax regulator, allegedly, chooses who to chase. However, before becoming cynical, embracing bogus tax scams or giving up, I’d ask this question: Are you taking advantage of the legal tax breaks that are afforded you? In other words, forgetting about what big companies are up to and putting aside your doubts about the IRS, have you truly worked with your tax advisor to leverage available tax breaks? In many cases, you don’t have to use gimmicks and play games. You just need to ask yourself if you’ve thought through all the opportunities.
Do you have the right tax structure? Consider the IRS data for 2012 tax returns: 1.9 million companies filed as some form of C Corporation, 3.6 million filed partnership returns (presumably many of them being LLCs) and an impressive 4.6 million filed as S Corporations. Before worrying about what big company moved which assets where, have you made sure you are not paying double taxes by being a C Corp? Could you save on payroll taxes if your LLC files as a corporation and elects S Corp status? Have you structured your business to be active, versus passive, in order to avoid the Net Investment Income tax?
Are you using the tax breaks often available to small businesses? Have you considered the Small Business Health Care Credit? It has been reported that this credit has low utilization in part because of its complexity. There are a number of available government and association tools that can make calculating this credit less daunting. Are you aware that the rules for the Home Office deduction have been liberalized, and can be utilized by more self-employed business owners? Similarly, are you still taking the per mile deduction for travel when it may be more advantageous to itemize your transportation expenses? What about hiring your spouse and children to work in your business? In many cases, there are ways to legitimately save taxes by having family members on the payroll.
Have you maximized what you can do with fringe benefits? There are some basic blocking and tackling techniques with fringe benefits that can save taxes. Whether it is life insurance, disability income insurance or long-term care insurance, there are ways to structure and pay for these benefits that can benefit your personal taxes. And, qualified plans offer a myriad of designs that can be tax-smart as well. Contrary to popular opinion, there are legitimate qualified plan designs that can disproportionately favor older and/or higher paid employees.
Have you looked at how you can save taxes on your exit plan? I often point out a business owner has a range of buy-out planning options that can vary from the plan being entirely non-deductible to being 100% deductible. So, for example, if I buy out my partner’s stock for a lump sum, it’s a capital purchase, and none of my payment is deductible. If, instead, I sell my business to an ESOP, potentially all of my gain is deferred plus the company can deduct all of its payments to me. Needless to say, there are buy-out design concepts that fall in between these two extremes from a tax-leveraging standpoint.
So before you get too caught up in political debate about what’s fair … and unfair … in taxes, I suggest you make the most of tax opportunities already available to you. The Clinton family is a good example. Both Bill and Hillary Clinton have been vocal about their belief in the need for a federal estate tax. This has not, however, kept them from maximizing their own estate tax savings planning. The Clintons created residence trusts in 2010 and shifted ownership of their New York house into them in 2011. These planning steps can help wealthy families reduce the sting of the 40% federal estate tax. As Justice Learned Hand so eloquently stated, “There is not … a patriotic duty to increase one’s taxes.”
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