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Making the Right Choices
Tax and Financial News
March 2005
Making the Right Choices
Well folks, the time is drawing near for the first big due date of tax season - March 15. Now donât panic; individual tax returns arenât due yet. If, however, you do business in some type of corporation, and your year-end is December 31, your business income tax return is due.
Thinking about the March 15 deadline got us thinking about some of the other choices that have to be made by March 15 for corporations with a December 31, 2004 year-end. Letâs take a look at a few of these other requirements.
First of all, letâs take a look at the type of corporation you own. There are two basic types of corporations we generally think of around tax time. The first is the C Corporation. For all intents and purposes, you can think of the C Corporation as a person from an income tax perspective. The C Corporation pays taxes on its income just like you and I would. While a C Corporation has distinct advantages when it comes to providing health and retirement benefits to its owners, it has one very big down side - double taxation. In general, dividend distributions from a C Corporation are generally taxable income even though the dividends are paid from after-tax money. While there are some exceptions, this generally holds true.
If you donât like the idea of paying taxes twice on the same income, you might consider the other type of corporation - the S Corporation. S Corporation income is generally taxed to the owners of the corporation on their individual tax returns. Whatâs even better is that distributions from an S Corporationâs profits are not subject to self-employment tax. This can be a very big advantage for those who have high levels of income. For example, during the last presidential election, someone found out that vice-presidential nominee John Edwards operated his law practice under an S Corporation. He did this because, after he paid himself a "reasonable" salary, he pulled the rest of his earnings out as distributions rather than income subject to FICA or Medicare tax. By establishing an S Corporation, Mr. Edwards was legally able to save hundreds of thousands of dollars in Medicare taxes. While some may have been outraged by this tax maneuver, we just had to admire his CPAâs competence.
There are good and bad points to whatever type of business entity you use, but make sure you follow the rules in making your elections. This brings us to the first March 15 reminder. If you want to change from a C Corporation to an S Corporation and you formed your corporation prior to January 1, 2005, you must make the election to change by March 15. If you do not make the election timely, donât worry, thereâs always next year.
Another election you need to consider is the election to amortize organizational costs and start-up costs. Luckily, these elections can be made on a timely filed return. As long as you file by the extended due date of your corporate return (generally September 15), you can make the election with no problem. Why is it important to make this election? Simply put, it is a use it or lose it type of election. If you do not make a timely choice to amortize the costs over a period of not less than 60 months, the costs are basically never deductible as long as the corporation stays in business. These costs can be substantial so donât lose the deduction.
Is your corporation on the accrual basis of accounting? If so, did you know that simply accruing expenses at year-end does not guarantee deductibility? For example, those bonuses you accrued for your salesmen must be paid within a reasonable period of year-end, or you can forget about deducting them until they are paid. The same goes for accrued vacation pay, accrued claims for health or workerâs compensation benefits under a self-insured plan and various other accrued expenses. Oh, did we tell you that "reasonable" generally means the expenses are paid within 75 days of year-end? The same generally holds true for payments under pension plans, except you have until the due date of the tax return, including extensions.
These are not the only elections that you need to make in a timely filed return, but they are some of the more significant elections. If you presently operate in corporate form, you may find it to your advantage to review your current tax status for savings that could be achieved by changing some of your tax elections. If your business is a new corporation, you need to look at your alternatives before you file your first return. Whether new or old, all businesses can benefit from a periodic review of their past tax decisions. Give us a call if itâs been a while since youâve reviewed your present form of doing business.
Have a terrific March.
Thinking about the March 15 deadline got us thinking about some of the other choices that have to be made by March 15 for corporations with a December 31, 2004 year-end. Letâs take a look at a few of these other requirements.
First of all, letâs take a look at the type of corporation you own. There are two basic types of corporations we generally think of around tax time. The first is the C Corporation. For all intents and purposes, you can think of the C Corporation as a person from an income tax perspective. The C Corporation pays taxes on its income just like you and I would. While a C Corporation has distinct advantages when it comes to providing health and retirement benefits to its owners, it has one very big down side - double taxation. In general, dividend distributions from a C Corporation are generally taxable income even though the dividends are paid from after-tax money. While there are some exceptions, this generally holds true.
If you donât like the idea of paying taxes twice on the same income, you might consider the other type of corporation - the S Corporation. S Corporation income is generally taxed to the owners of the corporation on their individual tax returns. Whatâs even better is that distributions from an S Corporationâs profits are not subject to self-employment tax. This can be a very big advantage for those who have high levels of income. For example, during the last presidential election, someone found out that vice-presidential nominee John Edwards operated his law practice under an S Corporation. He did this because, after he paid himself a "reasonable" salary, he pulled the rest of his earnings out as distributions rather than income subject to FICA or Medicare tax. By establishing an S Corporation, Mr. Edwards was legally able to save hundreds of thousands of dollars in Medicare taxes. While some may have been outraged by this tax maneuver, we just had to admire his CPAâs competence.
There are good and bad points to whatever type of business entity you use, but make sure you follow the rules in making your elections. This brings us to the first March 15 reminder. If you want to change from a C Corporation to an S Corporation and you formed your corporation prior to January 1, 2005, you must make the election to change by March 15. If you do not make the election timely, donât worry, thereâs always next year.
Another election you need to consider is the election to amortize organizational costs and start-up costs. Luckily, these elections can be made on a timely filed return. As long as you file by the extended due date of your corporate return (generally September 15), you can make the election with no problem. Why is it important to make this election? Simply put, it is a use it or lose it type of election. If you do not make a timely choice to amortize the costs over a period of not less than 60 months, the costs are basically never deductible as long as the corporation stays in business. These costs can be substantial so donât lose the deduction.
Is your corporation on the accrual basis of accounting? If so, did you know that simply accruing expenses at year-end does not guarantee deductibility? For example, those bonuses you accrued for your salesmen must be paid within a reasonable period of year-end, or you can forget about deducting them until they are paid. The same goes for accrued vacation pay, accrued claims for health or workerâs compensation benefits under a self-insured plan and various other accrued expenses. Oh, did we tell you that "reasonable" generally means the expenses are paid within 75 days of year-end? The same generally holds true for payments under pension plans, except you have until the due date of the tax return, including extensions.
These are not the only elections that you need to make in a timely filed return, but they are some of the more significant elections. If you presently operate in corporate form, you may find it to your advantage to review your current tax status for savings that could be achieved by changing some of your tax elections. If your business is a new corporation, you need to look at your alternatives before you file your first return. Whether new or old, all businesses can benefit from a periodic review of their past tax decisions. Give us a call if itâs been a while since youâve reviewed your present form of doing business.
Have a terrific March.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.
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