Small corporations are often run informally, especially when it comes to meetings.  Without layers of bureaucracy, officers and directors can make decisions with a quick conversation in the hall as easily as gathering around a conference table.  But whatever the forum, keeping minutes of your decision-making meetings is critical to your corporation.  Well-drafted corporate minutes can save you tax dollars, shield you from personal liability, and defend actions that other shareholders might later question.

Related to taxes there are a number of land mines that lurk in the tax code, ready to explode when corporations step on them. The corporate minutes should provide adequate explanations and details you’ll need to defend much of what the IRS might question in an audit.  Let’s review some of those danger zones:

Executive Compensation. 

If your corporation is a regular C corporation, the government taxes your corporate profits twice.  First, your corporation pays taxes on its income; then you pay personal taxes on dividends distributed from the corporation’s after-tax profits.  However, your compensation is taxed only once:  Although you pay personal taxes on it, your corporation can deduct it.

So the IRS is always on the alert for profits that find their way into executive compensation – salaries, bonuses, fringe benefits – all of which is deductible.  If it argues that your compensation package is excessive and unreasonable – and appears tied to company profits – it’s up to you to prove you’re not pulling an obvious tax dodge.

Your proof is in your corporate minutes.  They should show that your board of directors formally established executive salaries and raises before knowing what profits would be.  They also should contain the rationale behind the compensation levels you set: (1) the executive’s qualifications, including training, education, and experience; (2) the nature and complexity of his or her duties; and (3) comparable salaries in the same industry.

Bonuses are another sticky IRS wicket.  Many employee/shareholders take low salaries in the first half of the year, figuring they’ll make it up with year-end bonuses when the profit picture is clear.  But that pattern tells the IRS that your “bonus” is really a dividend in disguise.

If you use year-end bonuses, don’t wait to see what your profits will be.  Project your revenues at the beginning of the year, and calculate bonuses based on their expected increase.  Write it into your corporate minutes at that time, and you’ll have powerful ammunition if the IRS calls them dividends in disguise.

Also, don’t relate the size of bonuses to stock ownership – for example, a 60% bonus to a 60% shareholder.  (This can apply to salaries as well.)  The IRS will presume it’s a dividend.

Accumulated earnings.

It’s usually a good idea for a company to save money for a rainy day. Unfortunately, business owners can run into serious tax trouble if their corporations sock away too much cash, literally anything over $250,000. The tax trouble comes from the Accumulated Earnings Tax which is a 20% penalty tax on corporations (over and above any income tax to which a corporation is otherwise subject) buried in a little noticed Subchapter of the Internal Revenue Code.  

Although many businesses have tended to ignore this tax, the IRS is fully aware of it and is not shy about trying to impose it whenever it feels that “excessive” funds are being accumulated by a corporation. In fact, over the past few years, the IRS appears to be increasing its assertions of accumulated earnings issues in conducting corporate income tax audits.

So how do you satisfy the IRS that your cash buildup had a reasonable business purpose for the excess and that you’re not using a trumped-up excuse to avoid the tax? Through your corporate minutes, of course especially if you’re holding onto funds for purposes such as expansion, diversification, plant replacement; self-insurance; stock redemptions; working capital contingencies; and debt retirement.

Plans for retaining earnings can be immediate or long-range; as long as you document it, any good reason will get fair consideration.  The critical factor is intent:  It must be for a good business purpose in and of itself – not one to avoid taxes.

Shareholder transactions. 

The IRS will often look at dealings between a corporation and its shareholders with suspicion that you’re trying to avoid taxes.  Clarifying the issues in your minutes can help them pass muster.

For instance, loans from the corporation to shareholders might be seen as taxable dividends.  Your minutes can help back up their load status.  Similarly, if your corporation pays you rent, the IRS might say it’s too high and that the excess is taxable as a dividend.  But if your minutes show that the corporation investigated renting other properties and that yours was competitively priced and perhaps had other desirable features, the corporation may be allowed to deduct the full amount.

Personal-Liability Protection

Potential lawsuits are another important reason for keeping careful corporate minutes.  Courts can use them in deciding cases brought by creditors, dissatisfied minority shareholders, or anyone attempting to collect debts or challenge corporate decisions.

Say Supplier Smith sues John Doe, president of XYZ Corporation, for an unpaid corporate bill.  Smith claims XYZ is a sham corporation and that Doe is personally liable for the debt.  If XYZ has minutes showing it followed corporate procedures validating its corporate status, it could convince the judge to enforce the protection of the corporate shield.

Bottom line, if you want the advantages of having a corporation, you must follow the legal requirements for running it. If you do not abide the rules, you could find your business stripped of its legal status and the benefits of that status, such as

♦ Limited Liability

♦ Employee Fringe Benefits

♦ Business Credibility

♦ Tax Benefits

♦ Access to Commercial Loans & Capital Investment

♦ Perpetual Existence

Your first and best line of defense against losing the protection of your corporate status is to treat your corporation with respect. If you need help documenting formal corporate decisions, let Sage International, Inc. take the drudgery out of the necessary task by doing the work for you. We provide an easy and affordable solution called After the Inc. Dries®… in Minutes. Call if you want to learn more today.