Deduction Limitations of the Corporation and Individual

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This is the third section of Anker Reed HSC’s blog series entitled “To Incorporate or Not to Incorporate? That is the Question” regarding deduction limitations of the corporation and individual.

The corporation, on the other hand, is not affected by the § 67 limitation. A corporation will be allowed a one hundred percent deduction on itemized deductions. Therefore, in the foregoing example, the corporate taxpayer will be able to deduct the full amount of $50,000 without limitation. The corporation has effectively just saved the individual taxpayer approximately $4,000 in federal taxes and $1,000 in state taxes.

The subject of deduction limitations becomes more significant when addressing the issue of deductions allowed for medical expenses. An individual taxpayer can deduct the expenses for medical care of the taxpayer, his spouse, or a dependent to the extent that the expenses exceed 7.5% of the adjusted gross income. Using the previous example, if the individual had medical expenses of $25,000, they are not deductible because only those expenses that exceed 7.5% of the adjusted gross income are deductible. With an adjusted gross income of $500,000, the individual would need to have medical expenses of at least $37,500 before any deductions may be taken. In applying the applicable federal and state tax rates, the individual with $25,000 of medical expenses would pay a tax of approximately $12,500 ($10,000 to the federal government and $2,500 to the state government).

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

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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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