Monday, June 14, 2010

Corporations and Compensation

Although management in an S-Corporation and a C-Corporation may be very similar, wages may differ due to tax treatment of the entities. In an S-Corporation, shareholders are inclined to pay themselves a lower salary and take a larger distribution - taxed at ordinary rates on the flow through to the individual 1040. However, in a C-Corporation, income is taxed first at the entity level, and then again as a dividend. But C-Corporations have one major advantage over an S-Corporation, and that is the deduction of fringe benefits. A C-Corporation can deduct health insurance, and other fringe benefits paid to shareholders directly from income. In an S-Corporation, health insurance is added to the W-2 and taxed at the individual level. So in an S-Corporation reasonable compensation is essential as a lower wage may result in dividends being reclassified as wages. In a C-Corporation, high wages may be considered to be too substantial and reclassified as dividends, if wage and bonuses are to high. Therefore, before deciding on salary levels, it is best to check what is an equitable wage according to the IRS, and pay the dividend tax in C-Corporations.

Thursday, June 10, 2010

Partnership Basis

A partners basis in a partnership upon creation is the combination of cash, property and services contributed. A partners basis increases with cash contributions or increases in liabilities assumed by the partnership, and the distributive share of income. Basis decreases occur when money is paid to partners, liabilities decrease or distributive losses are incurred. Basis is also decreased with non-deductible expenses and section 179 expenses that are disallowed on the personal return.

A partners capital is usually tracked on the K-1 on a tax basis, unless the partnership has a GAAP balance sheet which is required when a M-3 is used.