2011 Tax Year Planning Tips

Tax planning for year-end 2011 presents new challenges for business taxpayers to reduce or defer federal income tax liability. Although traditional planning techniques remain fundamentally important considerations this year, tax planning is complicated in context of the effective dates for many popular tax incentives, and the anticipation of tax legislation that may be put to a vote in Congress before year’s end.

Patient Protection and Affordable Care (PPAC) Act

In March of 2010, Congress passed comprehensive health care reform legislation. The Patient Protection and Affordable Care (PPAC) Act was designed to effectuate fundamental reforms to the U. S. health care system. The new law includes over $400 billion in revenue raisers and new taxes on employers and individuals, including a 40-percent surtax on high-end employer–sponsored health plans, an increase in the employee portion of the Medicare tax for high-income taxpayers, new fees on certain health-related industries, shared responsibility for employers regarding health coverage beginning in 2014, and more.

Although provisions of the PPAC Act will be phased in over several years, eligible employers may claim a tax credit for employee health insurance expenses beginning in 2010; certain medical care tax benefits are extended to children under the age of 27 as of March 30, 2010; and in years beginning after December 31, 2010, certain small employer’s cafeteria plans can qualify as simple cafeteria plans, under which the applicable nondiscrimination requirements of a classic cafeteria plan are treated as satisfied.

In addition to the PPAC Act, Congress also passed the Hiring Incentives to Restore Employment (HIRE) Act in 2010 which provides tax breaks for businesses to encourage hiring and imposes a number of potential burdens with respect to reporting and disclosure of foreign assets. The Small Business Jobs Act of 2010 was designed to increase lending to small businesses and create incentives for small business investment with the extension of first year bonus depreciation, the extension and increased dollar amounts for Sec. 179 expensing, the five-year carry-back of qualified small business credits, and the removal of cell-phones as listed property.

At the end of 2010, within weeks of the scheduled sunset of numerous taxpayer-friendly tax rates and incentives, generally referred to as the “Bush Tax Cuts,” Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Tax Relief Act of 2010). The Tax Relief Act of 2010 temporarily extends all the Bush tax cuts for two years, reinstates the estate and gift tax (although at higher rates and with higher exclusion amounts than if the sunset had occurred), and extends many other expired tax benefits including business incentives and energy-related tax provisions. The Tax Relief Act of 2010 also includes an extension of unemployment insurance benefits and a one-year payroll tax cut.

Subsequently, the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011 repeals two recently enacted Form 1099 reporting requirements that many thought were overly burdensome on taxpayers and also makes changes to the recapture portion of the health insurance tax credit.

Considering this legislation, here are a few tax planning tips for year-end:

1. As of January 1, 2013, qualified dividends will be subject to ordinary income tax rates. Accordingly, corporations with excess earnings and profits should consider making larger dividends in 2011 and 2012.
2. The Code Sec. 179 deduction is limited to the taxable income of the taxpayer, whereas regular MACRS deductions are not. Foregoing the Code Sec. 179 deduction in 2011 may create a net operating loss for carry-back. However, Code Sec. 179 expense deduction in excess of current year income can be carried over to future years and effectively increase the deduction in years when the limitation is expected to decrease. Unless Congress changes the provisions, the expense limitation reverts to $25,000 in 2013.
3. In addition to the Code Sec. 179 deduction, the bonus depreciation deduction is extended to property placed in service before January 1, 2013.
4. The 15-year recovery period for qualified leasehold improvement property, qualified restaurant property (including restaurant buildings), and qualified retail improvement property applies to property placed in service before January 1, 2012.
5. The deduction for energy-efficient commercial building property is available for five years to include qualified property placed in service before January 1, 2014.
6. The recognition period for the S corporation built-in gains tax has been reduced through 2012. The relief provided by this provision should be valuable to small family or privately-owned businesses that are forced to downsize and sell assets to raise cash.
7. Advance planning is necessary to minimize the threat of the alternative minimum tax at a flat rate of 20 percent.
8. Enhanced deduction for food, book and computer donations.
9. Credit for increasing research activity
10. Work Opportunity Tax Credit
11. Credit for employer- provided childcare
12. Credit for employer’s differential wage payments to military personnel

Reproduced with permission from CCH’s Client Letter, published and copyrighted by CCH Incorporated, 2700 Lake Cook Road, Riverwoods, IL 60015. Our thanks to them. Please contact Mr. HVAC if you would like to be a guest writer.

How Much of a Salary or Draw Can You Take?

Salary & Distributions for S Corporation Officers and Shareholders

Many business owners who have incorporated pay themselves a draw or dividend in addition to or instead of a regular paycheck. This practice can get you in trouble if you don’t follow the 60/40 rule.

Courts have consistently held that S corporations must pay reasonable compensation to a shareholder-employee (owner) in return for services that the employee provides to the corporation before non-wage distributions (money paid to you that does not go through regular payroll) may be made to the shareholder-employee.  Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for the services rendered to the corporation.

According to the IRS, an owner/shareholder of an S-corporation you must pay them self a reasonable wage (through payroll).  At a minimum, you should pay yourself gross wages equal to 150% of the total you take out in draws/distributions.  This is known as the 60/40 rule.

Example: If you normally take $100,000 out of the business, it should be split so that $60,000 is paid as wages to yourself and the other $40,000 is paid out in distributions to yourself.  You have to be able to justify your pay as “reasonable”.  According to the IRS, reasonable pay is the amount that similar companies pay for the same, or similar, services.

Standard Payroll through Salary and Wages

Here we are referring to typical payroll that includes payroll taxes and withholdings.

• When you pay yourself a wage through your S Corporation, your business gets to take that amount as a deduction on the S Corporation tax return under Officer’ Compensation.
• Your business will also have to generate payroll reports and pay payroll taxes in a timely manner including the employer portion of Social Security and Medicare, federal unemployment, and state unemployment which are all deductible payroll tax expenses.
• You personally will have withholdings on your wages for Social Security, Medicare, federal income tax, and state income tax just as any other employee would.
• You will receive a Form W-2 at the end of the year from your payroll provider detailing the gross income and withholding amounts.  The gross pay included in Box 1 of your Form W-2 will be included as income on your personal tax return.

Draws, Distributions, and Dividends

Draws, distributions, and dividends are ways of paying yourself without creating an actual paycheck (or direct deposit) which includes the typical payroll taxes and withholdings.

• When you pay yourself distributions through your S-Corporation such as dividends, rents, personal expenses, and personal tax liabilities, these amount are not included as deductions on your business tax return (Form 1120S).
• The S-Corporation does not pay any payroll taxes on the distributions.
• The distributions that you receive are not deducted from your S Corporation’ income. You will not receive a W-2 or a 1099 for the distribution amount.  You also do not have to pay Social Security or Medicare tax on the distribution amounts.
• When you pay yourself using draws, distributions, or dividends, you are not withholding taxes. Many owners get themselves into trouble at tax time because they end up owing taxes they weren’t planning on. This can result in stiff penalties and interest. Be sure that you pay estimated taxes during the year.
• Possible IRS audit of the corporation’ records.
• Loss of S corporation status and liability protection.
• Distributions/Dividends being treated as wages with federal employment taxes being imposed and, subject to late payment penalties and interest for not paying these taxes on a timely basis.

Possible Consequences of Not Adhering to these Guidelines

• Possible IRS audit of the corporation’ records.
• Loss of S corporation status and liability protection.
• Distributions/Dividends being treated as wages with federal employment taxes being imposed and, subject to late payment penalties and interest for not paying these taxes on a timely basis.