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Income Tax Laws – I

Notes Laventhol and Horwath Small Business Tax Planning Guide. “You’ll end up paying radically
different amounts of income tax depending on the form you select. And your odds of being
audited by the IRS will change, too.” There are also some areas of tax planning that are specific
to certain business forms—i.e., sole proprietorships, partnerships, C corporations, and S
corporations.
Many aspects of tax planning are specific to certain business forms. Some of these are discussed
below:

(i) Sole Proprietorships and Partnerships: Tax planning for sole proprietorships and
partnerships is in many ways similar to tax planning for individuals. This is because the
owners of businesses organized as sole proprietors and partnerships pay personal income
tax rather than business income tax. These small business owners file an informational
return for their business with the IRS (Internal Revenue Service), and then report any
income taken from the business for personal use on their own personal tax return.
Since they do not receive an ordinary salary, the owners of sole proprietorships and
partnerships are not required to withhold income taxes for themselves. It is important
that the amount of tax paid in quarterly instalments equal either the total amount owed
during the previous year or 90 per cent of their total current tax liability. Otherwise, the
IRS may charge interest and impose a stiff penalty for underpayment of estimated taxes.

Since the IRS calculates the amount owed quarterly, a large lump-sum payment in the
fourth quarter will not enable a taxpayer to escape penalties. On the other hand, a significant
increase in withholding in the fourth quarter may help, because tax that is withheld by an
employer is considered to be paid evenly throughout the year no matter when it was
withheld. This leads to a possible tax planning strategy for a self-employed person who
falls behind in his or her estimated tax payments. By having an employed spouse increase
his or her withholding, the self-employed person can make up for the deficiency and
avoid a penalty. The IRS has also been known to waive underpayment penalties for
people in special circumstances.

Example: They might waive the penalty for newly self-employed taxpayers who underpay
their income taxes because they are making estimated tax payments for the first time.
Another possible tax planning strategy applies to partnerships that anticipate a loss. At
the end of each tax year, partnerships file the informational Form 1065 (Partnership
Statement of Income) with the IRS, and then report the amount of income. This income can
be divided in any number of ways, depending on the nature of the partnership agreement.
In this way, it is possible to pass all of a partnership’s early losses to one partner in order
to maximize his or her tax advantages.
(ii) C Corporations: Tax planning for C corporations is very different than that for sole
proprietorships and partnerships. This is because profits earned by C corporations accrue
to the corporation rather than to the individual owners, or shareholders. A corporation is
a separate, taxable entity under the law, and different corporate tax rates apply based on
the amount of net income received. Personal service corporations like medical and law
practices, pay a flat rate of 35 per cent. In addition to the basic corporate tax, corporations
may be subject to several special taxes.
Corporations must prepare an annual corporate tax return on either a calendar-year basis
(the tax year ends December 31, and taxes must be filed by March 15) or a fiscal-year basis
(the tax year ends whenever the officers determine). Most Subchapter S corporations, as
well as C corporations that derive most of their income from the personal services of

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