Page 61 - DCOM508_CORPORATE_TAX_PLANNING

Corporate Tax Planning

Notes 3.1.2 Tax Planning for Different Business Forms

“The first step in tax planning-for small business owners and professionals, at least-is to select the

right form of organisation for your enterprise,” is according to Albert B. Ellentuck in the 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 organised 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 percent 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 signifi cant
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 fi rst 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 maximise
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 percent. 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 fi scal-year basis
(the tax year ends whenever the officers determine). Most Sub-chapter S corporations,

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