There are quite a few ways to get cash, compensation or benefits out of your company. Each method may have different tax implications and of course, there is no single set of tax-savings strategies that work for everyone. However, if you stick to the “reasonable” test authored by the IRS (ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business), the likelihood that they will be disallowed or considered fraudulent is diminished especially. The deduction depends on your ability to prove a profit motive. Thus, you are not in business unless you are trying to produce a profit. When you are trying to make a profit, you may deduct your “ordinary and necessary” business expenses. If there is anything I would say it’s this, be as aggressive as possible but do not cheat! That means no personal, family or living expenses.
If you own your business, there’s no question that you have the right to the money the business earns, while paying the least amount of tax. So maximizing your deductible business expenses lowers your taxable profit while allowing you to enjoy personal benefits from a business expenditure. Note: For a number of benefits, you cannot discriminate in favor of the owners or highly compensated individuals only, if offering the benefit it must be available to all qualified employees.
- Dividends, or profit distribution (‘C’ Corp*, ‘S’ Corp or LLC depending on how it’s taxed). A dividend is a distribution of the corporation’s profits (can be in the form of cash, shares or tangible property like real estate or inventory) to the shareholders.*If you declare and issue dividends through a ‘C’ Corporation the income will be taxed twice. First it will be taxed as corporate profits at the appropriate corporate income tax rate. Then, it will be taxed as personal income to the shareholders, subject to their respective rates of taxation. Also, dividends are not considered a deductible business expense.
- Salaries. The IRS takes a long hard look at compensation for business owners. Is your salary too high (to avoid the double tax of issuing dividends?) or is your salary too low (avoiding payroll taxes?). The most natural measurement used to justify your wages is your role in managing and directing the affairs of the business. Plus, they measure against what you would be paid if performed the same duties for another company, what’s your background experience and education, and what’s going on with the national economy?Note: There are two ways that you can take income out of an S corporation; (1) Salary; and (2) distribution. The salary is subject to payroll taxes. The distribution is not. The rules say that an S Corp shareholder needs to take a salary based on what would be reasonable to pay someone else who did that job. What’s left can then be taken as a distribution. If an S Corp shareholder claims the only compensation they are taking is distribution, if audited, all that distribution will be subject to payroll taxes and you’ll be hit with a lot of interest and penalties. Don’t do it!
- Hire relatives. The money you pay will reduce business profits, you will have less taxable income to report. That compensation will be taxable to the relatives you hire (children or spouse) – or it might not. The standard deduction is $6,300 in 2015, so they can each receive up to that much, tax free. You do however, have to demonstrate and prove that they actually do work in the business. This is called income-shifting and is a tremendous wealth-building secret because it can add tax-sheltered dollars to the family bankroll. And as an employee, your spouse can participate in a variety of tax-sheltered corporate benefits.
- Bonuses. Bonuses need to be supported by established criteria early in the year like everyone gets a bonus if we hit our sales quotas or see year-over improvements. You have to be careful about awarding a bonus simply because you had a good year, if operating as a C corporation. The IRS calls that “Disguised Dividends:, which are subject to double taxation.
- Commissions. If your company depends heavily on sales, you can adopt a compensation package that includes commission on any sales you generate. Again, the commission structure should be established in advance and should be comparable to those paid to sales reps in competing businesses.
- Loans. To help ensure that amounts owed to the company by its shareholder(s) or member(s) of an LLC are bona fide loans, all parties, company and borrower, should sign a written note with commercially reasonable terms. The company should pass a resolution authorizing the advances, and the loans should be authorized in the minutes. Advances should be properly recorded, and the notes should include repayment schedules and maturity dates. Also, limits should be placed on the amount of advances. The notes should bear interest at a rate that is not less than the short-term applicable federal rate (AFR) on the date of the note (or blended AFR for demand loans outstanding for the entire year). The shareholder or member should repay principal and interest according to the terms of the note
- Leases. There are three types of goods that can be leased effectively: equipment, real estate/building, and employees. Example: If your business owns a building, we typically (Sage Int’l) will set up a second entity to hold title to the asset. The business then writes a check – the lease payment to the other business – which you also own – and literally provides an excellent opportunity to transfer taxable profits out of your primary business and into your pocket in a much more tax-advantaged way.
- Sale of Corporate Assets. Similar to a leasing arrangement, an owner can take cash out of business by selling assets to the business. The owner will show a gain or loss on the sale. For the sale to stand up to scrutiny, the transaction should be at a fair price and the company should be able to afford the payment.
- Employee Benefit Plans. The Affordable Care Act is a newsletter in and of itself as it relates to covering employees for health insurance only. There are so many issues, questions and consequences related to offering health insurance, I can only recommend you work with a local insurance agent that specializes in health care to figure out what makes the most sense for you, your family and your business.However, a company still can cover 100% of the costs for dental and vision insurance as well as offering Group-Term Life Insurance for $50,000 of coverage or Group Disability Insurance which is tax deductible to the business.Retirement Plans. Your company has a tremendous variety of options to consider when analyzing retirement and pension plans. A well designed plan can serve both as a tax deduction to the company and as a tax deferred nest egg that can compound over time. Tax rules on retirement plans are complicated, so professional guidance for setting up and maintaining plans is advisable.
Employee Assistance Program (EAP). This is a package of counseling services that an employer offers as a benefit to employees and their family members to help them address a wide range of personal problems that can affect job performance. Counseling services are designed to enhance wellness in the workplace by improving the emotional health of employees. EAP packages can be customized to meet the individual needs of employers.
Educational Assistance Plan. A company can provide up to $5,250 for tuition, fees, books, supplies and equipment for education that generally includes any form of instruction or training that improves or develops your capabilities each year. This also means that you do not have to include the benefits on your income tax return.
Day-Care Benefit. Any business can deduct the cost of a dependent or day-care assistance plan for its employees’ children under age 13. Payments for day care of up to $5,000 per worker annually are tax-free to the parent.
- Independent Contractor Fees for Services. If you have professional skills, outside the scope of your employment with the company, you can provide those services to the company, and the company can pay reasonable fees for the service.
- Fringe Benefits and Expense Accounts. This is the A-Z of deductible expenses to the business which provide a non-taxable benefit to the employees.Tax-Free Use of Property, Equipment and Services. This benefit is also known as working-condition fringe benefits which is defined as “any property or services given to an employee by an employer that would have been deductible or depreciable by the employee as a business expense had the employee paid for the property or services. For example, subscriptions to business publications, employer-provided cars, cell phone, membership in business associations, business travel, logo apparel, attending a TedX event, etc.De Minimus Benefits are those incidental benefits that are too small, or too inconvenient or costly to monitor like personal use of a copy machine, occasional company picnic, coffee and donuts, or a bouquet of flowers for your birthday.
Employee Discounts that offer staff to purchase the products of the business at a discount from the price charged to the general public.
No-Additional-Cost Fringe Benefits. Similar to employee discounts, this type of benefit involves services that the corporation provides to the public for a fee that an employee is entitled to use at a reduced cost or for free. An example would be an airline that allows employees to fly for free.
Expense Accounts. The company can also provide key employees with substantial expense accounts, allowing the employee to conduct business in a way that is reasonable and effective to market and promote the business. To ensure these expenses are deductible they must be substantiated with receipts and the specific business purpose of the expense.
Take recordkeeping seriously. Documentation is the key to sustain your tax position and it’s required by law. Plus the burden of support is on you, which means you have the total responsibility for proving your deductions. If you ignore the recordkeeping aspects then you are inviting disaster! If the IRS ever audits you or your business and finds insufficient records or significant mistakes (like benefit plans not being put in writing) it can disallow significant deductions. The IRS can impose hefty fines and penalties, which as we know can potentially force you out of business and wipe out your life savings as well. Recordkeeping must become a part of your everyday business routine!