Tuesday, August 31, 2010

5 Ways to Milk Preferred Tax Rates... Before Bush Tax Cuts Disappear

The end of the Bush tax cuts may just be a reality. Those rock bottom rates for long-term capital gains and qualified dividends are set to expire after 2010. Even if Congress extends the Bush cuts, they may limit the benefit for high-income earners. Here are a few things to consider:

Cash in your stock winners before 2011. If you wait until 2011, you generally will have to pay 5% more on long-term capital gains.

Harvest your stock losers after 2010. On the flip side, losses realized in 2011 may offset capital gains that will be taxed at higher rates.

Roll over or sell “small business” stock. If you own qualified small business stock, you can avoid tax on a sale by rolling over the proceeds into other QSBS stock within 60 days. Alternatively, you can exclude tax on 50% of the gain from the sale of QSBS in 2010 or 2011 , but the capital gain rate is 28%.

Take dividends in 2010. There is a urgent tax incentive to pile up dividends this year. If it makes sense, invest in stock a few months (now may be a good time) before dividends are scheduled to be paid. If you own a closely held corporation or a personal holding company, now may be the time to pay dividends.

Pass on the installment sale tax break. If it makes sense, you can elect out of installment sale treatment and have the entire gain taxed at 15% in 2010. Remember, this will accelerate your tax liability for both federal and state tax purposes.

Monday, August 16, 2010

S Corporation Tax Reduction Strategies

You may be receiving several types of payments from your S corporation, including a salary, rental payments from leasing real estate to the corporation, and a portion of the S corporation's net income. Since even minor fluctuations in these payment categories can produce differing tax results, we have the following ideas for saving taxes when extracting S corporation cash.

Income Shifting
S shareholders often attempt to minimize their compensation to increase the pass-through income to other owners (typically children in a lower tax bracket. Clearly, an owner rendering significant services to the corporation cannot unreasonably reduce salary to increase income to other shareholders. However, reasonable adjustments may be made with this objective in mind.

Reducing Compensation
Wages paid to an S corporation shareholder-employee are subject to payroll taxes. However, pass-through S corporation income is not. Thus, shareholder-employees may be able to reduce their payroll tax liability by minimizing salaries to receive additional pass-through income.

The IRS is aware of this strategy and has successfully fought it in several court cases. In some cases, the corporation issued no compensation to the key employee providing virtually all of the services the corporation sold. Instead, the shareholder-employee took corporate distributions without incurring payroll taxes. The courts recharacterized the distributions as compensation and imposed payroll taxes. Despite these IRS victories a shareholder's salary may be adjusted to the lower end of a reasonable range, especially when services are not the primary income-producing activity of the corporation.

Generating Rental Income
It is generally beneficial for an owner to rent real estate to the S corporation because any resulting net rental income is exempt from payroll taxes. But the arrangement must be reasonable because the IRS has ample authority to recharacterize rent payments as compensation or dividends to the extent they exceed market rates. S corporation shareholders using portions of their homes to perform services for the corporation (or to store corporate inventory) may lease space to the corporation. Deductions are not available for this use, but the rent is exempt from payroll taxes.

S corporation shareholders can often choose how to structure funds extracted from the corporation. While compensation and rental amounts must be reasonable, shareholders' tax results can often be improved. To discuss how S corporation distribution strategies can improve your tax situation, please give me a call.