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Tax planning for small business: a dozen helpful strategies.

Recent changes (effective in 1997) in the Internal Revenue Code (IRC), and already existing IRC sections provide an opportunity for tax practitioners to give valuable advice to their clients, especially small business clients. These small businesses employ a significant percentage of the U.S. population and the federal government has numerous provisions in place that can assist small businesses; whether those businesses are just starting or have been in existence for some time. Some of the provisions were designed specifically for the purpose of encouraging small business activity in the U.S. This article provides an introduction to some of the income tax provisions that have the most wide-spread impact and provisions that can be most beneficial to small businesses. Tax practitioners may want to refer to specific sections of the Internal Revenue Code for more information on some of these provisions. The authors have cited relevant IRC and Treasury Regulation sections as appropriate for this purpose.

The article divides these 12 potential tax benefits for small businesses into three categories: those that directly benefit the firm, those that directly benefit the owners, and those that directly benefit the employees. For all three categories of items, however, the firm will also benefit. Any tax provisions that help the employees or owners will also indirectly help the firm.

CORPORATE BENEFITS

Graduated Tax Brackets

One of the most obvious, yet underrated, provisions of the tax code favorable to small business is Internal Revenue Code (IRC) [section]11.(1) This section stipulates the tax rates applied to corporations. The current corporate tax rates start at 15% and increase to 35 percent. Section 11 provides brackets for taxation as follows:
Taxable Income Marginal Tax Rate

$0-50,000 15%
$50,000-75,000 25
$75,000-$10 million 34
Over $10 million 35


In addition, the IRC provides for a phaseout of the benefits of the lower tax brackets using "bubble" tax rates. For corporations with taxable income above $100,000 an additional 5% tax is due on the excess earnings above $100,000, up to a maximum additional tax of $11,750. For corporations with taxable income above $15,000,000 an additional 3% tax is due on the excess earnings above $15,000,000, up to a maximum additional tax of $100,000. The effect of these additional taxes is to eliminate the tax benefits of the lower tax brackets. Effectively, corporations with taxable incomes of greater than $335,000 are taxed at a flat tax rate of 34% and corporations with taxable incomes of greater than $48,333,333 are taxed at a flat tax rate of 35 percent. Section 11 therefore starts eliminating the greatest effects of the lower tax brackets when corporate taxable income reaches $100,000.

The tax rate of corporations varies considerably over a relatively short range. While corporations with taxable incomes of $50,000 are taxed at a flat rate of 15%, corporations with taxable incomes of $335,000 are taxed at a flat rate of 34 percent.(2) This is a range of 19% of taxable income and is a considerable difference in the portion of taxable incomes paid to the federal government. Numerous states also have graduated tax rates for their corporate taxpayers. Overall, this can be a tremendous advantage for small corporations.

For tax planning purposes, clients with highly fluctuating taxable incomes (high taxable income one year and low taxable income the next year) may wish to try to level out taxable income figures over years. One method that might help do this is the cash method of accounting.

Example 1:

Corporation B has an income of $20,000 in year 5 and $80,000 in year 6. This results in total tax over the two years of $18,450. If this income were evenly spread over the two years, the total tax would be $15,000; a tax savings of $3,450. One way to more evenly spread the income is the use of the cash method and, in this example, allowing payables to accrue at the end of year 5 to be paid in year 6.

Cash Accounting Method

The IRC requires businesses to use the same accounting method (e.g., cash or accrual) for tax purposes that it does for financial accounting purposes. In general, C corporations must use accrual accounting for income tax purposes. According to IRC [section]448, partnerships (without C corporation partners), S corporations, any businesses in farming or timber, and small C corporations(3) can elect to use the cash method of accounting for tax purposes. However, any business in which sale of inventories is an income producing factor must use the accrual method of accounting for inventory. The major advantage of cash accounting is the opportunity to affect taxable income at year-end by manipulating cash. This can be done by paying more or less cash on payables, or purchasing more inputs.(4) In addition, farms may elect to sell or store their inventory (grain or livestock) at year-end or hold these sales over to the first of the next year.

Form 1120-A

Small corporations benefit from filing Form 1120-A as opposed to filing the longer form 1120 for income tax reporting. To file this shorter form the corporation: cannot be a member of a controlled group or file a consolidated return; cannot own foreign stock or have a majority (at least 50%) foreign investor; cannot be currently liquidating or being dissolved; must have total income and total gross receipts each under $500,000.

If the corporation meets these requirements, it can file the shorter Form 1120-A. Filing this form can reduce the tax compliance costs of the firm. The first page of Form 1120-A is very similar to the first page of Form 1120. Form 1120, however, has four total pages of required information, not counting possible supplemental schedules. The second page of the two page Form 1120-A requests some of the same information from the last three pages of Form 1120, but much of the information requested on Form 1120 is not requested on Form 1120-A. For example, Form 1120-A does not require Schedule A calculation of cost of goods sold, Schedule C disclosure of dividends, Schedule E information about compensation of officers, or the M-2 analysis of retained earnings per books. Page 2 of Form 1120-A continues to require the computation of income tax, other (condensed) information about the firm, a balance sheet, and a reconciliation of income (loss) per books with income per return.

Tax compliance costs are a significant portion of the total tax bill. Each measure that helps reduce tax compliance costs can greatly add to your client's bottom line.

IRC [section]179 Immediate Expensing of Long-Lived Assets

IRC [section]179 allows small businesses to immediately expense certain depreciable capital expenditures. Businesses may expense up to $18,000 in 1997 (increased each year to $25,000 in 2003) of costs of [section]1245(5) property placed into active service that year. The limit, however, is phased out dollar for dollar as the business places into service assets with costs exceeding $200,000 in a year. The deduction is also limited to current taxable income. This deduction allows small businesses to immediately expense assets that would otherwise have been depreciated over several years.

For tax planning purposes, tax practitioners should consider both of the above limits (i.e., $18,000 maximum deduction per year and phase out beginning at $200,000). If your client needs $40,000 of new qualifying assets in 1997 you could help the client maximize the deduction by recommending acquisition of about half in one year and about half in the next year - resulting in the $18,000 deduction in 1997 and $18,500 in 1998. Another client needing $500,000 of qualifying assets could maximize the deduction by acquiring no more than $200,000 of qualifying assets in one year and the remainder the next year. In this way, your client would realize the [section]179 deduction in one of the two years (as opposed to no deduction in either year if the business acquires half the desired assets in each of the two years).

IRC [section]44 Disabled Access Credit

IRC [section]44 allows small businesses to claim tax credits for making their facilities more accessible to disabled individuals. This provision may be especially useful to clients subject to the Americans with Disabilities Act (ADA). Section 44 expenditures may include costs to remove structural barriers, change existing facilities, or to add required facilities. The credit is equal to 50% of the expenditures over $250, up to the maximum credit of $5,000. The original property (before the [section]44 expenditure) must have been originally placed into service before November 5, 1990. The credit is limited to businesses with 30 or fewer full-time employees and gross receipts (reduced by returns and allowances) of $1,000,000 or less in the previous year. The company claiming the credit may be a C corporation, S corporation, partnership, or sole proprietorship. The depreciable basis of the capital improvements must be reduced by the amount of the credit claimed.

Any business with an existing building visited by customers may take advantage of this provision to build ramps, expand doorways, install an elevator, etc. Tax practitioners should advise their clients to consider this provision when choosing a new location. If the building was originally placed into service after November 4, 1990, the credit is not available. For buildings placed into service earlier than November 5, 1990, the credit is available and should be considered in negotiating the purchase price.

OWNER BENEFITS

IRC [section]351 Nonrecognition of Gain or Loss

IRC [section]351 provides what might be a tax advantage on the formation of (or later asset transfer to) a corporation. This section requires the deferral of gain or loss recognition on such transfer if three requirements are met:(6) If prospective shareholders transfer (1) property to the corporation in exchange for (2) ownership interest in the corporation and (3) immediately after the transfer the parties involved in the transfer hold at least 80% of the total voting power and total number of shares of stock, then no gain or loss shall be recognized on the transfer. The theory behind this section is that individuals have merely changed the form of doing business and, since no cash changed hands, the individuals involved have no wherewithal to pay taxes. This section can be advantageous because it allows individuals to start a corporation or add more property to an existing corporation without having to recognize gain and pay taxes on that gain. Individuals making a [section]351 transfer need not file any additional forms. The application of the section is automatic and required.

The section requires transfer of property for stock in that corporation. Services do not qualify as property. Therefore, individuals must still recognize income on services rendered. In addition, if an individual provides only services to the corporation in exchange for stock, this individual's stock ownership, after the transfer, does not qualify for the ownership test. This individual would recognize services income and any other individuals making transfers to the corporation, if the ownership test fails, must recognize gain or loss on the transfer.

The [section]351 transfer is most advantageous to small business because it is difficult or impossible for shareholders of larger businesses to meet the ownership test. Stock holdings for the 80% ownership test include only the stock holdings of individuals making the current property transfer. The transfer must occur as a planned, coordinated effort and proceed "with an expedition consistent with orderly procedure." (T. Reg. [section]1.351-1[a][1])

Tax practitioners should warn their clients of several potential pitfalls concerning [section]351 transfers.

Example 2

Bob, Rex, and Jane form BRJ corporation. After the transfer, Bob, Rex, and Jane hold 60, 15, and 25% of the stock, respectively. Bob transferred land worth $60,000, with a basis of $20,000. Rex transferred cash of $15,000, and Jane provided legal and accounting services to setup the corporation. Because Jane did not transfer property and Bob and Rex together do not meet the T. Reg. [section]1.351-1 ownership test, Bob must recognize a [TABULAR DATA OMITTED] gain of $40,000 on the transfer. Bob will be taxed on this gain.

The taxpayers involved in example 2 could help Bob avoid this gain recognition in at least two possible ways. Jane could formulate her services into a plan of incorporation and operation (essentially performing all the services before incorporation) and then offer this package to the corporation as property. Jane's stock ownership would then also be includable in the 80% stock ownership test and Jane would not recognize service income. Another solution is for Jane to also contribute property. With this solution, Jane would still recognize service income on the services she provides, but all of her stock would count for the 80% stock ownership test, preventing Bob's recognition of gain. In this second solution, the property Jane transfers must have more than a nominal value (generally at least 10%) compared with the services Jane contributed for Jane's stock ownership to be includable in the 80% ownership test.

The provisions of [section]351, including nonrecognition of gain or loss, are mandatory. Clients may, at times, wish to avoid compliance with [section]351, especially if loss realization is anticipated, and its recognition for tax purposes is desired. There are several possible ways to avoid [section]351. Generally, these possibilities include some method to avoid the ownership test. For example, the individuals making the transfer of the loss property might make the transfer at a separate time from the transfer of other assets (not in a coordinated plan) and therefore avoid [section]351. Also, your client could sell the property, even to the corporation, and then contribute the asset(s) received for the property to the corporation for stock. The individual would recognize the loss and still contribute the same market value to the corporation.

Subchapter S Corporations

Subchapter S corporations are a popular business form. While there are many large S corporations, most S corporations are small (at least in comparison with the size of the largest C corporations). S corporation status is elective. Thus S corporations must first meet the requirements to be a C corporation.(7) These corporations may then elect to operate as S corporations. Corporations must meet certain statutory requirements to elect and receive S corporation status and must continue to meet these requirements to maintain S corporation status.(8) In 1996 the U.S. Congress loosened the [section]1361 requirements to elect S corporation status. The current requirements include:

* must be a domestic corporation,

* banks and insurance companies cannot be S corporations,

* essentially limited to one class of stock,

* maximum of 75 shareholders,

* only individuals, estates, and certain trusts can be shareholders,

S Corporations must continue to meet these requirements. In addition, to elect S corporation status requires an affirmative vote of all shareholders. Loss of S corporation status occurs through violation of one of the above restrictions, individuals holding a majority of the stock vote for revocation, or earning excess passive investment income over three years.(9) The restriction of the number of owners to 75 restricts the corporation's ability to raise capital and therefore its size.

S corporation status is an election, not a requirement. Therefore, the IRS has strictly administered the provisions pertaining to S election. For example, failing to file for S corporation status, even if the IRS lost the form, resulted in denial of S corporation status, and possibly severe negative tax consequences. The 1996 law, however, allowed for more flexibility regarding S corporation status, including "backdating" the election under certain circumstances.

The major advantage to S corporation status is single taxation. While C corporation earnings are taxed at both the corporate level (when the corporation earns the income) and the shareholder level (when the corporation distributes the income), the earnings of the S corporation are taxed only once (at the shareholder level when the corporation earns the income).

There are several potential disadvantages or pitfalls with S corporations. One disadvantage of S corporation status is that shareholders may not receive distributions in the same period that they are taxed on S corporation income. Also, the above requirements are continuing requirements of the S corporation. Violation of any of these requirements can result. in the loss of S corporation status. This means that the S corporation would be taxed as a C corporation. Traditionally, the IRS has been quite strict about adherence to the requirements for S corporations and might even determine an S corporation was, in essence, a C corporation retroactively, possibly several years later. The 1996 law is much more lenient and gives the IRS the right to waive invalid S corporation elections. Therefore, violations of the S requirements (e.g., failing to file or to get all shareholder consents) will not necessarily result in loss of S corporation status, if such conditions are remedied in a reasonable time.

IRC [section]1044 Gain Rollover

IRC [section]1044 allows investors to defer (roll over) gain realized on the sale of publicly traded securities to the extent that the proceeds are invested within 60 days in a qualified Specialized Small Business Investment Company (SSBIC). To qualify as an SSBIC a partnership or corporation must be certified by the Small Business Administration under [section]301(d) of the Small Business Act of 1958 as modified through May 13, 1993. This Code section is intended to help small businesses attract capital. Shareholders must recognize gain to the extent proceeds from the stock sale are not reinvested in qualified stock.

There are both annual and lifetime limits for this deferral. The annual limits are $50,000 for individuals and $250,000 for corporations. The lifetime limits are $500,000 for individuals and $1,000,000 for corporations.

IRC [section]1202 Capital Gain Exclusion

IRC [section]1202, enacted in 1993, is a relatively new code section and its benefits will not be available until 1998. Section 1202 requires exclusion of half the gain realized from stock issued after August 10, 1993, held for 5 years, and sold for a gain. The purpose of the section is to encourage investment in small business.

The issuing corporation must be a qualified C corporation with no more that $50,000,000 in gross assets.(10) This limit applies before, during, and after the stock issuance. The C corporation must have no more than 20% of its assets invested in the following areas:

* professional services,

* banking, lending, finance, insurance, leasing, or similar endeavors,

* farming,

* oil, gas, or mineral exploration,

* hotels, motels, restaurants, or similar businesses.

At least 80% of the corporation's assets must be invested in the qualifying business, and no more than 10% of the net assets may be invested in securities. The corporation must report to the IRS periodically to maintain its qualification.

The exclusion applies to individuals only, although actual ownership may be through a trust, partnership, or S corp. The individual must acquire the stock directly from the corporation or receive it through gift or inheritance.

There are two limitations on the amount of the gain eligible for exclusion. The eligible gain over the taxpayer's life may not exceed $10,000,000 per corporation. Also, the gain may not exceed ten times the individual's basis in the stock. The five-year waiting period may be a disadvantage for the investors, and the extra reporting requirements impose an extra cost on the corporation.

For tax planning purposes, practitioners and their clients should pay particular attention to the requirements of [section]1202 at all times, including after the date of stock issuance. If the sum of the aggregate gross assets of the company, including the receipts from the new stock issue, exceeds $50,000,000 the new stock will not be [section]1202 stock. During the time investors hold [section]1202 stock the company must report periodically to the IRS. The stock may lose its [section]1202 status if the company violates one of the [section]1202 requirements (e.g., invests more than 10% of its assets in securities, or more than 20% of its assets in nonqualifying businesses). Because this exclusion is a tax preference item, tax practitioners must remember to include this item in the calculation of the alternative minimum tax. Also, this provision may not appear as attractive if Congress passes a general capital gains break.

IRC [section]1244 Ordinary Loss Recognition

IRC [section]1244 is an attempt to enhance investment in small corporations. Section 1244 allows the conversion of what would otherwise be capital losses on stock to ordinary loss recognition. The only requirements are that total capital of the company be no more than $1 million on the day of the stock sale (including the [section]1244 stock issued) and that the original investor is the stockholder on the date of the stock loss. Also, passive income cannot constitute 50% of more of the corporation's total income over the last 5 years before the date of the [section]1244 stock loss. Total capitalization can exceed $1 million after the stock is issued without affecting [section]1244 provisions. The shareholders can be either individuals or partnerships.

The conversion of capital loss to ordinary loss is limited to $50,000 ($100,000 for married taxpayers filing jointly) per tax year (for all [section]1244 losses of the taxpayer in that year). If the original purchase of the stock included transfer to the corporation property with a basis in excess of market value (loss property) then the calculation of the amount of the [section]1244 loss is determined using the property's market value as the basis of the stock. (i.e., The [section] 1244 loss is limited to the difference between the stock's market value and the market value of the property given for the stock.) In this way individuals cannot convert what would have been capital losses into ordinary losses.

For tax planning purposes, if your client realizes a [section]1244 loss in excess of $50,000 ($100,000 for married couples) the individual should sell only enough stock in one year to recognize up to the conversion limit each year. Your client should do the same the following year. Any loss in excess of the limits may be deducted as a capital loss, subject to capital loss limitations.

Section 1244 is a no lose situation. Electing [section]1244 when the stock is issued results in capital gain treatment for gains on stock sales and ordinary losses for at least some of the losses on stock sales.

EMPLOYEE BENEFITS

IRC [section]219 SIMPLE Retirement Plan

IRC [section]219 is new in 1997. IRC [section]219 started the Saving Incentive Match PLan for Employees (SIMPLE) retirement plan. Businesses with 100 or fewer employees earning at least $5,000 in compensation in the preceding year qualify if the firm does not have another employer-sponsored retirement plan.

There are several advantages to the SIMPLE retirement plan. The reporting procedures are less burdensome than other retirement plans. Also, SIMPLE plans are not subject to the nondiscrimination or anti-top-heavy rules of other retirement plans. This means that top managers may take a larger percentage of the total pension plan payments. Employees vest immediately and contributions are tax-deferred until withdrawn.

There are some disadvantages to the SIMPLE retirement plan. Contributions may not exceed $6,000. (The firm may match this amount, for a total pension payment of $12,000.) This plan may not be the best choice for businesses with owners who expect to earn high salaries and to make large pension contributions. Also, there is a rule that employers must match at least 1% of each employee's income; for companies with highly variable earnings, this rule may become a hardship in years when earnings and/or cash flows are low. Employees who withdraw contributions within the first two years they are eligible for a SIMPLE plan will be assessed a 25% penalty tax.

Tax practitioners should advise their clients to carefully weigh the tax consequences of their pension plan before starting or switching to a SIMPLE plan. The SIMPLE plan must be the only plan a company offers, so there will be no other pension opportunity for the owner/operator. Also, the lack of top-heavy rules may be more than offset by the upper limit on contributions.

IRC [section]220 Medical Savings Account

IRC [section]220, new in 1997, provides a medical savings account (MSA) plan. The plan works like an IRA, in that contributions by the employee are deductible for AGI (before taxable income). If the employer makes the contributions, they are generally not included in the employee's income for the year. Contributions may be made to the plan until the employee files his/her tax return. Distributions are not taxable if the money goes to qualified medical expenditures. (There are penalties for using the money for any other purpose.) Initially, sole proprietorships and companies with 50 or fewer employees qualify. After a company has qualified, it does not lose qualification until the year after it grows to more than 200 employees.

The MSA is an experiment and will expire in 2002.(11) Enrollment is limited to the first 750,000 participants. The employee or the employer may make contributions to the MSA up to 65% (75% for families) of the deductible amount of the medical insurance policy. Only high-deductible medical insurance plans may be used in conjunction with an MSA. High-deductible means that the deductible must be at least $1,500 for an individual, or $3,000 for a family.

The MSA has advantages for the employer and the employee. High-deductible insurance will cost the company less than more traditional low-deductible plans. The employees will benefit from the current deductibility of their contributions, the fact that they grow tax-deferred, and the fact that unlike the currently popular flexible savings account, the contributions may carry over from one year to the next.

The MSA has disadvantages. The MSA requires high-deductible medical insurance. While high-deductible plans cost less for the company, this may cause a problem for the participants, particularly in the first year before the employee has built up a carryover balance to pay the high deductible. Some state laws require lower deductible amounts than the amounts specified by [section]220. Businesses in these states may therefore be barred from participating in an MSA.

Tax practitioners should advise clients considering participating in the [section]220 experiment to enroll quickly. The IRS will check the 750,000 participant limit periodically. Once 750,000 employees participate no new participants will be allowed until the number of participants drops below 750,000.

Summary

The Table provides a summary of the requirements and benefits for each of the above provisions. Tax practitioners should remain aware that there are many different definitions of small business or small corporation in the tax laws. Meeting the small business requirements of one section of the IRC does not guarantee conformity with other sections. Also, some sections require conformity with the definition of small business only at one time (e.g., [section]1244) while other sections require continued adherence to the requirements (e.g., S corporations).

Also, the IRC specifies that beneficial provisions of the IRC are allowed to be members of a controlled group only once. IRC [section]1563 defines a controlled group for this purpose. Corporations may be members of a controlled group by being parent-subsidiaries, brother-sister controlled groups, or both parent subsidiary and brother-sister controlled groups.(12) Such controlled groups will be treated as one taxpayer for federal tax purposes. While these controlled groups may legally have several businesses, the IRS recognizes the controlled group as only one business and allows only one use of the graduated tax brackets, [section]179 deduction, etc.

The checklist provides a convenient tool for tax practitioners to use in advising their clients about the possible benefits of each of the above IRC sections. As always, tax practitioners should keep up with changes in the tax law, as these IRC sections are subject to change at any time.

SMALL BUSINESS TAX PROVISIONS CHECKLIST

Lower tax rates:

* Is your firm's taxable income approximately, or under, $100,000?

* Is your firm not a member of a controlled group, as defined in IRC [section]1563(a)? (Corporations in controlled groups are considered as one entity for purposes of the graduated tax brackets.)

Cash Accounting Method:

* For any entity form, does your firm rely on income generation in some way other than selling inventory?

* For partnerships (other than farms), are all partners noncorporate?

* Is the firm an S corporation?

* For C corporations, is the firm in the trade or business of timber or farming, or is the firm otherwise a small corporation (average annual gross receipts of $5 million or less average over the last three taxable years)?

Form 1120-A, for a C corporation:

* Are gross receipts, total income, and total assets each $500,000 or less?

* Is the corporation not in dissolution or liquidation or filing a consolidated return?

* Foreign investors do not own at least 50 percent of the stock?

* Does the corporation have no foreign investment?

* Is the corporation not a member of a controlled group per IRC [sections]1561 and 1563?

Immediate Asset Expensing:

* Did the company place up to, but not over, $218,000 of [section]1245 property into service during the year?

* Is the taxpayer not an estate or trust?

Disabled Access Credit:

* Was the original property, to which improvements apply, placed in service before November 5, 1990?

* Does the company have 30 or fewer employees?

* Does the company have gross receipts of $1 million or less?

Nonrecognition of Gain on Transfer to Corporation:

* Did the owner(s) transfer property (as opposed to services) to the corporation?

* Did the contributors receive stock in the corporation?

* Do the [section]351 contributors own at least 80 percent of the corporation after the transfer?

S Corporation Election:

* Is the corporation a domestic corporation?

* Are there 75 or fewer owners of the corporation?

* Do the owners consist of only individuals, estates, and certain trusts?

* Is there only one class of stock outstanding?

* Is the corporation operating in industries other than banking and insurance?

Stock Gain Deferral:

* Did the former owner(s) reinvest the proceeds in a qualified small business (SSBIC)?

* Is the owner still within the deferral limits of $50,000 per year and $500,000 per lifetime?

Capital Gain Exclusion:

* Was the investment in a C corporation with $50 million or less in assets?

* Was the stock issued at least 5 years prior to the sale?

* Is the C corporation involved in an industry other than professional services, banking, lending, finance, insurance, leasing, farming, oil, gas, or mineral exploration, hotels, motels, restaurants, or similar businesses.

* Did the original investor (including transfers by gift or inheritance) hold the stock the entire time and was this investor the person to take the loss?

Ordinary Loss Recognition:

* Did the original investor hold the stock the entire time and was this investor the person to take the loss?

* Was the total capital of the corporation no more than $1 million on the stock issue date?

* Was passive income less than 50 percent of total corporate income over the last 5 years before the [section]1244 stock loss date?

SIMPLE Retirement Plan:

* Does the company have no other retirement plan?

* Does the company have no more than 100 employees earning $5,000 or less?

* Is the plan set up so that each employee earning at least $5,000 may participate?

Medical Savings Account:

* Is the company a sole proprietorship or does it have 50 or fewer employees (fewer than 200 employees for a continuing qualifying company)?

* Does the firm have a health insurance plan with high deductibles?

* Are the employees in the firm among the first 750,000 to enroll?

If you answer yes to all the applicable questions in any of the above sections, then your firm may be able to take advantage of tax savings available from that IRC Section.

Endnotes

1. The same principle applies to individuals. Individual tax rates are graduated and have phase-out "bubbles." S corporations and partnerships, as flow-through entities are generally not taxable at the federal level. The discussion of graduated tax rates therefore focuses on federal corporate taxation.

2. The highest tax rate (not including the bubbles) after $335,000 is only 1 percent higher.

3. Small corporations, for this code section, are those with average annual gross receipts of $5 million or less over the last three taxable years.

4. All businesses must account for long-lived assets (with lives of at least one year) by capitalizing and depreciating the assets

5. IRC [section]1245 property is tangible personal property used in the business to produce income (e.g., equipment)

6. Section 721 is similar for partnerships, although [section]721 has only two requirements: transfer of property to a partnership for partnership interest. As [section]721 does not have the ownership requirement of [section]351, [section]721 does not restrict nonrecognition of gain or loss to small businesses.

7. The requirements for C corporation status have recently changed. As of January 1, 1997 new business entities can elect their business form for federal tax purposes. This Treasury Regulation is popularly known as "check the box." This regulation allows businesses to select whether they wish to be taxed as corporations or partnerships for federal tax purposes. The previous requirements for corporate status required meeting at least three of the four criteria in the now superseded T. Reg. [section]301.7701. These four criteria were centralized management, free transferability of ownership interests, continuity of life, and limited liability. While these criteria are no longer relevant at the federal level (as long as the new T. Reg. withstands the test of judicial review) states may still require adherence to these criteria to define a corporation for state tax purposes.

8. Again, state law may differ regarding S corporation status. While many states follow federal recognition of S corporation status, some states do not recognize S corporations or may have different requirements for S corporation status.

9. An S corporation with accumulated earnings and profits from C corporation years and passive investment income in excess of 25 percent of gross receipts for three consecutive years loses its S corporation status in the fourth year. In addition, this S corporation would be subject to excess passive investment income tax for each year.

10. IRC Section 1202 defines gross assets as cash plus the aggregate adjusted basis of all the assets held before the stock issuance except that contributed property is valued at fair market value.

11. The Health Insurance Portability and Accountability Act requires two studies, one by the Treasury Department and one by the General Accounting Office. The experiment may be extended depending on the results of these studies.

12. A parent subsidiary controlled group exists when the parent corporation owns at least 80 percent of the voting power and at least 80 percent of the stock value of the subsidiary. A brother sister controlled group exists when five or fewer individuals own at least 80 percent of the value or voting power of the corporations and hold more than 50 percent of the common ownership (value or voting power) across all the corporations.
COPYRIGHT 1998 National Society of Public Accountants
No portion of this article can be reproduced without the express written permission from the copyright holder.
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Author:Bjornson, Chris; Barney, Douglas K.
Publication:The National Public Accountant
Date:Jan 1, 1998
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