Nicholas Paleveda for ProducersWeb.com writes: Here are five tax plans every financial advisor, CPA and attorney must know:
5. Set up an S-Corporation
This plan is simple. Set up an S-Corporation and
distribute profits using a K-1 as opposed to salary. The taxpayer will
save the payroll taxes, which may be as high as 15.3 percent each year.
One case, Watson v. Commissioner 668 f.3d 1008 (8th Cir. 2012),
involved a sophisticated CPA who understood that a lower income would
mean lower payroll taxes. However, a shareholder-employee’s compensation
from an S-Corporation is often subject to IRS scrutiny, because
S-Corporation flow-through income enjoys an employment tax advantage
over that of sole proprietorships, partnerships and LLCs.
This
advantage is mentioned in Revenue Ruling 59-221, which held that a
shareholder’s undistributed share of S-Corporation income is not treated
as self-employment income. In contrast, earnings attributed to a sole
proprietor, general partner or many LLC members are subject to
self-employment taxes. Watson paid himself $24,000 in salary during 2002
and 2003 while withdrawing over $375,000 in distributions. The court
determined a reasonable compensation amount of $93,000, requiring Watson
to re-characterize $69,000 of distributions in each year as salary.
Even if this was the case, Watson would still save the additional
payroll taxes between his salary and the taxable wage base.
Unfortunately, a radio advisor did not understand this basic plan. Dave Ramsey, who often gives advice on his radio show to individuals, recently stated the following to one of his callers.
April 29th 2014 Dave Ramsey Show 1:43:53
Facts of the case:
1. Martin from Atlanta 2. 1099 self-employed sub-contractor doing
outside sales for construction company 3. Caller is trying to figure
out from a tax perspective if he should incorporate as an S-Corp
Martin: “Trying to figure out if I should incorporate?”
Dave: “No.
There is no tax savings in incorporating or turning an LLC. The only
reason you would do those two things is if you have a potential
liability or you’re afraid you’re going to get sued over something and
you needed a corporate veil ... I don’t recommend incorporating
something like you’re talking about ... It adds to your cost because you
have to have that corporate return prepared every year ... I can’t
address Georgia because I don’t know, but on a federal level you don’t
save any money by having a sub-S ... I wouldn’t do it ... It’s just too
much hassle.”
Of course the advice was free and the caller received what he paid for: nothing
.
4. Set up a SEP
The IRS publishes the form;
the IRS makes available the rules; and the plan can be established as
late as the due date of filing your tax return. The SEP is a simplified employee pension, but is not a pension; it is an IRA under the defined contribution rules.
Like any tax plan, it is complicated and built to stay that way.
The
taxpayer adopts the model form and can place up to 25 percent of their
compensation — to a maximum of $52,000 in 2014 — into a SEP and deduct
the compensation from federal income taxes, state income taxes, Social
Security taxes, Medicare taxes and Obamacare taxes.
What’s the
problem? The same formula must be used for all the employees and
companies do not want to “give” their employees 25 percent of pay. The
problem of employee cost and the $52,000 limit is solved with the next
plan.
3. Set up a DB-DC plan
The plan is a defined-benefit plan (DB
plan) “cross tested” with a defined-contribution plan. The old rule
401(a) (26) placed into ERISA in1974 states the defined benefit plan
must include 40 percent of the eligible employees to pass the “minimum
participation” test. This means you can “exclude” 60 percent from the
defined-benefit plan.
Example: Company A has
two doctors, two spouses and six employees. The two doctors and two
spouses are in the DB plan and the six employees are “excluded” from the
DB plan. However, “excluding” does not mean you can “ignore” these
employees for “testing” other sections of the internal revenue code. The
plan must pass the “minimum aggregation allocation gateway” test, which
in English means the employees must receive 7.5 percent of pay,
generally in a profit-sharing plan. The plan must also pass 401(a) (4)
independently, which means that EBARS and rate groups need to be
established. This is a plan you should not try at home and engage an
“enrolled actuary” to perform these tests. (That is, if you can find
one. According to Google there are 4,700 in the U.S.)
However,
the results can be favorable for a client who is interested in a tax
deduction of up to $350,000 (in some cases). The DB plan allows
tax-deductible contributions, which are not subject to the $52,000 limit
but are actuarially calculated.
2. Set up a captive insurance company
Captive
insurance companies have been around for a long time. In fact, most of
the Fortune 500 companies have established captive insurance companies.
However, Rent-A-Center 142 T.C. No. 1 United States Tax Court 2014, is recent. Below is the holding from the case.
Rent-A-center
corporation is the parent of numerous wholly owned subsidiaries,
including L, a Bermudian corporation. P conducted its business through
stores owned and operated by its subsidiaries. The other subsidiaries
and L entered into contracts pursuant to which each subsidiary paid L an
amount determined by actuarial calculations and an allocation formula,
relating to workers’ compensation, automobile, and general liability
risks, and, in turn, L reimbursed a portion of each subsidiary’s claims
relating to these risks. P’s subsidiaries deducted, as insurance
expenses, the payments to L. In notices of deficiency issued to P, R
determined that the payments were not deductible.
Held: P’s subsidiaries’ payments to L are deductible, pursuant to I.R.C. sec. 162, as insurance expenses.
What
does this mean for tax planning? In a captive that maintains the 831(b)
election, the first $1,200,000 in premium is not included in income.
These “micro-captives” allow company A to transfer risk to company B,
which they control, and receive a $1.2 million deduction. Employees do
not have to be included in this plan. Of course the company has to
“insure” risk of the parent and operate as an insurance company. Today,
the captives may be incorporated in the U.S. with Vermont being the
leader and Florida updating their 1982 statute in 2012 to compete for
the “captive” formations.
1. Set up a "Double Irish Dutch" company
Tax
planning cannot get better than this corporate tax shelter. While the
“boss” and “son of boss” both have been blasted, this shelter has held
its own better than the US 20th Maine did at Gettysburg.
This
plan has been called the “Google” tax shelter or “Apple Inc.” tax
shelter. According to some commentators, Microsoft, Facebook and other
companies have already engaged in this type of planning.
Imagine
that the country of Ireland has a treaty with the United States, and
the tax rate in Ireland is 12.4 percent as opposed to 35 percent in the
U.S. It would benefit any company to have income flow to Ireland as
opposed to the U.S. Imagine if you had technology (such as a search
engine) which could be easily transported and owned by your Irish
company. Set up Irish holdings, sell the search engine to them and pay
rent for its use. Now the income flows to Ireland and your tax is at
12.4 percent.
Imagine the Netherlands does not have a treaty
with the U.S. like Ireland but does allow the Irish company to transport
their earnings tax-deductible to them and then on to Bermuda where the
assets can accumulate tax-free. Now the tax on the search engine
earnings virtually disappears in the quagmire of international entities.
For more on this, see “Stateless Income” by University of Southern
California Professor Edward Klienbard, Florida Tax Review, Vol. 11 p.699
(2011).
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