Advanced Underwriting Consultants

Question of the Day – June 21

Ask the Experts!

Here’s the question of the day.

Question: My client owns a company organized as a C corporation.  Isn’t double taxation a potential problem for him?

Answer: Many business owners are inclined to reject C corporation status because of double taxation.  How does that work?

If a C corporation makes money, its taxable income is subject to federal income taxes.  If, for example, in 2012, a C corporation makes $100,000 of taxable income, it owes the federal government $22,250.  That leaves $77,750 after-tax profit.

If the company decides to distribute that profit to one of its shareholders as a dividend, the dividend is taxed again—this time to the shareholder.

Because corporate profits distributed this way are taxed twice—once at the company level, and once personally—the tax process is sometimes referred to as double taxation.

As a practical matter, double taxation hits most often at large, publicly traded companies where the potential tax effects of dividends on its shareholders is not a big concern for company management.

At a closely held business, company management and ownership are usually the same person or group of people.  Where management has the ability to decide whether company profits will be distributed, it usually has the flexibility to decide to avoid double taxation.

Here’s one way it might do so.  Say that Fred is the 100% owner of a C corporation, and he is also the company’s key employee.  His company is on track to make $100,000 of taxable profit in 2012.  Fred does not want that $100,000 of profit to be taxed twice.

Fred can decide to pay himself a bonus of $100,000 near the end of the year.  So long as Fred’s overall compensation package is reasonable, the bonus is tax deductible by the company.  So after the bonus is paid, the company’s taxable income is completely eliminated.  There would be no corporate income tax on the profit—because the profit has been eliminated.

Fred does have to pay income tax on the bonus that he gets, but that’s the only tax that has to be paid.  And that result is no worse than if Fred were organized as a pass-through entity.

Here’s another way that Fred can avoid double taxation.  Instead of paying a dividend—or paying himself a bonus—Fred decides to keep the $100,000 profit, which is $77,750 after federal income tax, in the business.  Fred and the company may use the money to buy equipment or to make another investment to help the business grow.

The business profit is only taxed once in the second example—at the business level.  Because Fred doesn’t directly enjoy the profit himself, he doesn’t have to pay personal income tax on it.  The money is used to re-invest in the business itself.

In some instances, being able to decide to keep company profits inside the business creates a lower overall income tax result than if the company is a pass-through entity.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.

Question of the Day – January 31

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: Can the owner of a C corporation realize any tax advantages by running the premium for a qualified long term care policy through her business?

Answer: Yes.  Qualified long term care contracts are generally treated as health insurance for the purpose of the rules.

C corporation employers have the greatest number of potential advantages for implementing LTCi plans for their employees.

1. The premium is deductible by the corporation. LTCi premiums payable by a company are deductible as ordinary and necessary business expenses under Code Section 162.

2. There is no practical limit to the amount of premium that can be paid by the employer’s for an employee’s policy. The amount of premium that a business contributes to LTCi on behalf of an employee is virtually unlimited—subject only to the idea that the employee’s overall compensation package is reasonable.

3. The company can pick the employees to be covered by the plan. Health plans provided by an employer through insurance coverage do not need to follow the nondiscrimination rules of Section 105(h) of the Code.  Code Sections 105 and 106 make reference to health plans sponsored by an employer.  Treasury Regulations Section 1.105-5 provides

a plan may cover one or more employees, and there may be different plans for different employees or classes of employees.  An accident or health plan may be insured or noninsured, and it is not necessary that the plan be in writing or that the employee’s rights to benefits under the plan be enforceable.

4. The premium paid by the corporation is not included in the employee’s taxable income. Code Section 106 says that the premiums paid by an employer to a health plan are not included in the employee’s taxable income.

5. The benefits paid to the insured are tax free. Section 105(b), however, provides that an employee does not have to include in taxable income most payments received for medical care, as defined in Code Section 213(d).  Section 213(d) says benefits paid under a tax-qualified LTCi contract are payments for medical care.

6. Spouse and dependent family members of participating employees may also be included under the plan. Section 105(b) of the Code allows employers to include spouses and income-tax dependents of participating employees within the scope of a health plan.  Since LTCi plans are health plans for the purpose of Section 105(b), that means that the spouse or income-tax dependents of a participating employee can also be included in the LTCi plan so long as the employer permits.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.