Q:

Subject: Corporation S vs. C

 

Dear Mr. Kerry,

I would like to tell you that I  really enjoyed reading your web site, I think it's very informative and knowledgable. It prompted me to do a research about the benefits of corporation C vs. S.  Both, my husband and I currently own a corporation S, and as you pointed out there are a few downsides of such entity. Passed on taxes are obviously some issue which affects us in two ways:

1. it inflates our income and that becomes an obstacle in applying for a student loan (I have 4 high school/college age children),

2. The taxes that we pay on 1040 are partially owed by the corporation. At the end, the corporation "owes" us some money and it always takes a lot of time to pay ourselves back ( not to mention that the due taxes are higher because of the tax brackets).

I've also  learned from your web site that as a corporation C we would be able to benefit more with the medical reimbursement plan. I am curious though, if being an officer of the corporation, I can provide myself with a different level of medical reimbursement, than for the other two employees of my company. I'm not trying to be cheap, I just can't afford an extensive medical coverage for my employees yet. I  work on this issue with my CPA but she wasn't sure if the reimbursement plan  can be different for officers and other employees.She also wasn't sure if a part time employee is eligible for such benefit. So, I was wondering if you could provide some insights on this issue.

Also,  I was always wondering what is behind "royalty payments" that you mentioned on your web site.

I would really appreciate your comments on this issue. ( I've already consulted two tax lawyers, but sadly they weren't very helpful)

Thank you in advance

A:

IRS is very strict regarding discrimination in regard to employee benefits.  This does mean that every eligible employee has to be allowed to have the exact same benefits as the top brass. 

There are several long used ways around this that any experienced tax pro should be able to help you with.  For example, I have seen countless doctors who don't want to provide full benefits to all of their staff; so they set up a separate management corporation, which only employs the doctor and his/her family members.  The management corp has a generous benefit plan, while the other corp (with the non-family employees) doesn't have such a plan. 

Another technique I have seen used is to only work with incorporated service providers.  Payments to corporations cannot be considered employee payroll because corporations are not human, a basic requirement for employees.

The employer can establish the eligibility thresholds for inclusion in the benefit plans, such as age, full time vs. part time and years of service.  These have to be reasonable and in compliance with your state's labor laws.    

Royalty payments are similar to what franchisees pay to the main franchise HQ for the use of the company name and operating standards.  For example, if you set up a corporation and design its operating manual and provide it with certain key technology and customers, you can license the use of those to the corp.  The income would be reported on Schedule E of your 1040 and would not be subject to SE tax.  The amount or rate would need to be reasonable.  I have seen people use flat amounts per month or year, as well as percentages of gross revenues, which is more like conventional franchise agreements.

None of these concepts are new or out of the ordinary.  Any experienced tax pro should be able to help you set things up in the best manner for your situation.

Good luck.

Kerry Kerstetter

Follow-Up:

Dear Mr. Kerry,

I just wanted to say thank you for your quick and detailed respond.  After many thoughts I decided to revoke my S status and I hope that in my situation I could benefit from this decision. I will continue using your resourcefull web site, where I can find great amount of practical knowledge. I know that you don't accept any new clients but maybe in the future you will consider organizing some seminars?  I'm pretty sure it would be very popular and you'd have an audience from all over the country. Maybe one day?

Thank you again,

 

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 3/17/2006 10:35:00 AM Send this post: