A Question of Tax Structure
The Single Most Important Decision In the Formation and Operation of Your Business
The top-earning 25 percent of the US taxpayers pay 5 out of every 6 tax dollars collected according to the Tax Foundation data, based on information released by the Internal Revenue Service. The top 5 percent of taxpayers earned 34 percent of the income in 1999. In that year, the top 5 percent of income earners paid 55 percent of the total individual income taxes. (This does not even include federal taxes paid by individuals who own their own corporations or state/local income tax.) You are in this group if your income is $120,000 or higher! If you are not in this group, you are working your way toward it. As your income rises, you will struggle even more to keep what you have earned. You will pay out an increasing portion of your income as tax.
'Americans at the upper end of the income scale continue to bear an increasing share of the total federal individual income tax burden. In a progressive tax system like ours, economic growth results in a steady shifting of the tax burden up the income scale.' Tax Foundation Special Report 'Who Pays the Federal Income Tax?' February 2002. Taxes are the largest single category of expense in our lives. Therefore, managing the tax is critical.
How do you manage taxes? By planning and directing how your business is structured. This means that by choosing an appropriate business structure, you will help minimize your tax liability.
Which is the Best Structure for my Business?
Clients ask me that question all the time. What do I mean by structure?
I mean what type of entity or combination of entities should your business use: Sole Proprietorship, Corporation (C-Corp or S-Corp), Partnership or Limited Liability Company (LLC).
Sometimes clients don’t ask that question, and I see that nobody evaluated the issue (at least, not recently), and consequently the taxpayer is needlessly paying substantially more tax than necessary.
What are the relative advantages and disadvantages of each business structure?
This subject could take up the space of an entire technical book, but may be more than most business owners want to know.
However, a careful technical analysis and the answers it yields are more important than any single tax deduction, because the structure selected for a business will determine the set of tax laws, and rules and rates by which it will be taxed.
A quick decision based on misinformation, incorrect assumptions, or 'rules of thumb' can be very costly, especially compounded as the years roll by.
'That’s the way we always do it' can be a very costly way to think.
Dual Tax Structure
Beyond a simple single business structure is the unusual and powerful tax-cutting combination of two or more of the above. I call this the dual tax structure, essentially splitting the business into two (or more) parts. Of course, there must be a legitimate business reason to divide a business into two operating units. Using a dual tax structure, the business can benefit from the best (most advantageous) aspects of two different tax strategies, rather than being limited by the disadvantages of the best decision afforded by a single business structure. An additional benefit of splitting a business into two parts is a limiting of liability and protection of assets in the unlikely event of an adverse legal judgment.
Evolving Tax Structure
A business may start out small. The appropriate tax structure may be a sole proprietorship. As it grows, it may become appropriate to change the form to an S-corporation. Later, at the appropriate time, it will become necessary to add a sole proprietorship or C-corporation. Salaries and fringe benefits packages may become a part of a structure that changes as the profitability grows, and tax laws evolve.
1) A common example of this is a business owner or professional who owns the real estate (building) where his business is located. The business may operate as a Subchapter-S Corporation and pay rent to the owner of the land and building which is in the form of a sole proprietorship or partnership.
2) Another example of a dual tax structure is a professional practice (law, medicine, architecture, engineering, etc.). The firm may actually have a consulting, speaking/lecturing or book authoring business as well as its professional practice, or two practices in two different states or regions. This is an area for consideration and planning.
3) A final example: A business may have a retail sales operation and a service/installation business. Such a business really should be structured as two separate businesses.
They must be asked and answered for each entity … for maximum tax efficiency.
What is the most tax efficient business form?
Sole Proprietorship, Corporation (C-Corp or S-Corp), Partnership or Limited Liability Company (LLC)
What is the optimal level of rent?
What is the optimal level of compensation of each employee?
What sixteen categories of tax-free fringe benefits can we use to lower profits and, therefore, taxes?
Which tax-free fringe benefits are subject to anti-discrimination restrictions? And which are not?
How can we legally avoid anti-discrimination restrictions of tax-free fringe benefits by utilization of the proper structure?
Should the business hire a spouse or children?
If so, what would be the optimal salary level?
What would be the optimal tax-free fringe benefit mix?
Can the business owner realize a tax benefit from an office in the home?
Are there even better options than office-in-home?
At what points should the structure evolve into a different form?
How can we manage the relationships between entities and their owners for the lowest total tax, with efficiency and simplicity?
The business owner must engage in a careful analysis with the assistance of a skilled and experienced tax specialist CPA to sort through the complex decision making process. How does the current business structure affect the level of taxes paid? The business owner must consider how the business has developed and a vision for future growth of the business.
After the business owner has asked these questions and received answers with the assistance of a qualified tax professional, then an informed decision may be made. The role of the tax specialist accountant is to communicate to the client how to implement the chosen tax structure and provide continuing advice. Together, they can manage the tax relationships of the entities in the business structure. How can we utilize the structure we have chosen and established, in an efficient manner?
Set-up Costs and Annual Costs
There are costs associated with this type of analysis, process and transition, but the potential tax benefits are much greater than these costs. There is a set-up cost to establish a corporation: state filing and processing fees, if that is necessary. There is a one-time cost for a C-Corp, S-Corp or sole proprietor Spouse Employment Contract (fringe benefits package), if that is necessary. There is a cost for analysis and consultation in the form of professional fees.
There may be additional annual operating costs for preparation of additional entity returns, additional costs for payroll taxes and the associated costs for their preparation. Even with these 'up front' and ongoing costs, the potential tax and financial benefits are much greater than all of these costs combined.
For most small business entities, the tax reduction ranges from $6,000 to $80,000 per year. This is real money, not a tax deduction or credit. Over ten years, this can cumulatively total $60,000 to $800,000.
Who can help?
Effective professional tax planning advice is the most lucrative investment in your business you can make.
Does it really pay to have somebody in control of your tax relationship with the state and federal government who is not a complete expert, a top man in his field?
Robert Greene can simplify the issues, clarify confusion and answer these questions.
Robert Greene is a rare and gifted accountant who has the formal education, professional credentials, professional experience, technical knowledge, analytical ability, communication skills, and the ability to think independently and critically. He is committed to tax efficiency at a reasonable price.
What’s the most important thing to do right now?
Call 845-889-4439 to schedule an appointment with Robert Greene, CPA, CMA.
He has three offices in New York, with a fourth virtual (telephone) office for clients across the United States.
Meetings can be arranged in the New York area or on site at the business location anywhere in the United States.