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Unit 3: Tax Planning: An Introduction

shareholders, are required to use the calendar-year basis for tax purposes. Most other Notes
corporations can choose whichever basis provides them with the most tax benefits. Using
a fiscal-year basis to stagger the corporate tax year and the personal one can provide
several advantages.

Example: Many corporations choose to end their fiscal year on January 31 and give their
shareholder/employees bonuses at that time. The bonuses are still tax deductible for the
corporation, while the individual shareholders enjoy use of that money without owing taxes on
it until April 15 of the following year.

Both the owners and employees of C corporations receive salaries for their work, and the
corporation must withhold taxes on the wages paid. All such salaries are tax deductible for
the corporations, as are fringe benefits supplied to employees. Many smaller corporations
can arrange to pay out all corporate income in salaries and benefits, leaving no income
subject to the corporate income tax. Of course, the individual shareholder/employees are
required to pay personal income taxes. Still, corporations can use tax planning strategies
to defer or accrue income between the corporation and individuals in order to pay taxes in
the lowest possible tax bracket. The one major disadvantage to corporate taxation is that
corporate income is subject to corporate taxes, and then income distributions to
shareholders in the form of dividends are also taxable for the shareholders. This situation
is known as “double taxation.”
(iii) S Corporations: Subchapter S corporations avoid the problem of double taxation by passing
their earnings (or losses) through directly to shareholders, without having to pay dividends.
Experts note that it is often preferable for tax planning purposes to begin a new business
as an S corporation rather than a C corporation. Many businesses show a loss for a year or
more when they first begin operations. At the same time, individual owners often cash
out investments and sell assets in order to accumulate the funds needed to start the business.
The owners would have to pay tax on this income unless the corporate losses were passed
through to offset it.

Another tax planning strategy available to shareholder/employees of S corporations
involves keeping FICA (Federal Insurance Contributions Act) taxes low by setting modest
salaries for themselves, below the Social Security base. S corporation shareholder/
employees are only required to pay FICA taxes on the income that they receive as salaries,
not on income that they receive as dividends or on earnings that are retained in the
corporation. It is important to note, however, that unreasonably low salaries may be
challenged by the IRS.
The key objective in effective corporate tax planning is to identify the main factors in the
organisation’s structure that dictate the opportunities for tax efficiencies.

!
Caution What tax planning is not...
1. Tax Planning is NOT tax evasion. It involves sensible planning of your income
sources and investments. It is not tax evasion which is illegal under Indian laws.
2. Tax Planning is NOT just putting your money blindly into any 80C investments
3. Tax Planning is NOT difficult. Tax Planning is easy. It can be practiced by everyone
and with a very little time commitment as long as one is organized with their
finances

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