The Tax Benefits of Incorporation to the Entertainer (Part 3)

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This is part 3 of the second section of Anker Reed HSC’s blog series entitled “To Incorporate or Not to Incorporate? That is the Question” regarding the tax benefits of incorporation to the entertainer.

In order to minimize the obvious deleterious effects of the higher tax rate applied to PSCs, it is common for the PSC to “zero-out” at the end of its tax year. This means that the net income of the corporation is paid to the shareholder-employees in the form of compensation and retirement benefits, leaving little or no taxable income for the imposition of tax. This also eliminates any risk of a taxing agency re-characterizing the income as constructive dividends, imposing taxes on shareholders and the corporation.

The most significant tax benefit of using a loan-out is the increased deductibility of their business, medical, and in some cases, even personal expenses.  As opposed to the individual taxpayer, the corporate taxpayer has more tax-beneficial requirements and limitations on deductible expenses. First, an individual taxpayer is limited in the amount of itemized deductions she may have. Section 67 of the Internal Revenue Code states that miscellaneous itemized deductions are allowable only to the extent that the aggregate of the expenses exceeds two percent of the adjusted gross income. This means that all of the itemized deductions over two percent of the adjusted gross income is deductible.

For example, if the adjusted gross income for an individual taxpayer is $500,000 and the miscellaneous itemized deductions are $50,000, the first $10,000 (2% of $500,000) will not be deductible. Therefore the individual taxpayer will be able to deduct only $40,000. Therefore, the taxpayer will still be taxed on the non-deductible $10,000 at the federal rate of 39.6%, approximately $3,960. When adding to this the state tax rate, the amount taxed could approach 50%.

* For specific inquiries regarding a tax planning legal matter that you may have, you are welcome to visit our Los Angeles Tax Planning Attorney services page.

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To Incorporate or Not to Incorporate? THAT is the Question (Part 5)

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This is part 5 of Anker Reed HSC’s blog series entitled “To Incorporate or Not to Incorporate? That is the Question”.

Partnerships and limited liability companies are treated for tax purposes as conduits whose income and deductions pass through to the partners or members as they are realized, with the various items retaining their original character in the process.” (Fundamentals of Corporate Taxation 703, 4th ed. 1997) The partnership will still file an income tax return with the government, but this tax return will solely be for informational purposes. The individual partners pay the actual tax.

For example, a partnership that has taxable income of $1,000,000 for the taxable year will pay no tax on this income. The partners will pay the tax. Should there be two partners, each partner will have taxable income before individual deductions of $500,000. It is important to note that percentage of control in a partnership may be negotiated amongst the partners, in that a partnership may not always be 50/50. For this analysis, and in the interest of simplicity, we will assume a 50/50 partnership. This amount does not include amounts paid by the partnership to the partners as compensation, or in any other form, received during the taxable year.

In applying § 1 (c) of the Internal Revenue Code, each partner’s assessed tax before individual deductions will be $77,485 plus 39.6% of all income over $250,000. Therefore, in the absence of any other personal deductions, each partner’s tax will be approximately $176,485.  The partnership itself will not be subject to tax, but “the persons carrying on business as partners shall be liable for income tax only in their separate or individual capacities.” (I.R.C. § 701, Supp. 2000).

* For specific inquiries regarding a tax planning legal matter that you may have, you are welcome to visit our Los Angeles Tax Planning Attorney services page.

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