By: William J. Barnes, CPA, CVA, MST

When choosing to incorporate a business an important decision to consider is whether to be a C Corporation or an S Corporation. The right choice can save you income taxes and employment taxes as well as other headaches.

Below is a 10,000 foot view that can help you analyze which business form is right for your particular situation.

Basics

Main difference is a C Corporation pays federal income taxes on its business income. An S Corporation generally pays no federal income tax on its business income. Rather, the shareholders of the business pay income tax on the business income on their personal tax returns.

Example

Lets say ABC Corporation has taxable income of $1,000,000 – below is comparison of different tax consequences (ignoring state taxes):

                                                                        C Corp                       S Corp    

Taxable Income                                          $ 1,000,000                 $1,000,000

Federal Tax at 34%                                    ($  340,000)                 $          0

Cash Available S/H - Dividend                $    660,000                 $1,000,000

Tax to Shareholder Dividend 15%          ($    99,000)

Tax on Income S/H 35%                                                                   ( $350,000)

Net Cash to S/H                                           $    561,000                 $   650,000

Effective Tax Rate                                              43.9%                         35.0%

Additional Tax C Corporation                   $      89,000

You might think that, based on this example and tax savings, an S Corporation is always the better choice. However, choosing the better corporate tax treatment is a little trickier than it appears.

Reasons to choose C Corporation status:

Ø  Graduated tax rates – tax rate on first $50,000 of income is 15%.

Ø  Income is expected to be $100,000 or less.

Ø  More income can be retained for future growth because of graduated rates.

Ø  Tax free fringe benefits.

Ø  Flexibility for tax year ends.

Reasons to choose S Corporation status:

Ø  Avoid double taxation on profits.

Ø  Saving on employment taxes.

Ø  Can shift income to family members who are taxes at lower rates.

Ø  Greater flexibility to use cash method of accounting.

Ø  For tax years beginning after December 31, 2011, S Corporations will no longer be subject any Michigan Corporate Income Taxes.

By default a corporation is generally considered a "C" corporation. If you desire to be taxed as an "S" corporation you must file a Form 2553 to inform the IRS that the shareholders desire (elect) this tax treatment.

Not all corporations may elect S status. The election is only available to qualifying small business corporations who have no more than 100 shareholders, only one class of stock and eligible shareholders.

Careful planning should go into the decision to be a C Corporation or an S Corporation. Taxpayers should seek out professional tax advice to help in the decision process.

Note: Congress may retroactively amend some or all of these items

By William J. Barnes, CPA, CVA, MST

Business Tax Changes

• The research and development and work opportunity tax credits expire
• The enhanced charitable deductions for contributions of food, books, and computer technology expire
• The special S corporation built-in gains tax suspension period of 5 years expire – goes back to old law 10 years
• The 15-year recovery period for leasehold improvements, restaurant property, and retail improvements expire
• The 100% bonus depreciation deduction will be scaled back to 50% in 2012
• The Section 179 deduction limit will fall from $500,000 this year to $139,000 in 2012
• Work Opportunity Tax Credit not available except for hiring qualified veterans
• Longer write off period for specialized realty assets – qualified leasehold improvements, qualified restaurant property and qualified retail improvement property placed in service after 2011 a 39 year write off period applies – up from 15 year 

Individual Tax Changes

• Deduction of $250 for elementary and secondary school teacher expenses expires
• Deduction for state and local sales taxes expires
• Deduction for mortgage insurance premiums expires
• Deduction for qualified tuition expenses expires
• Tax-free distributions from IRA’s for charitable purposes expires
• Reduced adoption credit – total expenses that nay be taken as a credit reduced to $12,650 – credit is no longer refundable
• Non-business Energy Property Credit expires
• Allowance of personal tax credits against Alternative Minimum Tax
• Exclusion of 100% gain on certain small business stock

By: William J. Barnes, CPA, CVA, MST

Michigan Gov. Rick Snyder has recently signed legislation to adopt a corporate income tax and substantially revise the personal income tax by lowering the rate, curtailing deductions and exemptions, and eliminating credits.

The corporate income tax (“CIT”) is effective January 1, 2012, and the Michigan Business Tax (“MBT”) is repealed after all certificated credits and any carryforward have been claimed. We discussed the personal income tax changes in last week’s blog. The major corporate changes are discussed below:

Income Tax Base

The CIT is a 6 % tax on apportioned and allocated income of a C Corporation with $350,000 or more of apportioned gross receipts. In contrast to the MBT, sole proprietors and flow-through entities will not be subject to CIT. This will be a welcome relief for many small businesses. However, flow-through entities, owned by corporations or individuals, will need to comply with new withholding requirements. Flow-through entities not owned by corporations will pay tax on apportioned business income based on a single factor under the individual income tax system.

The tax base for the CIT is federal taxable income subject to the following addition and subtraction adjustments:

• bonus depreciation is added back;
• the federal domestic production activities deduction is added back;
• interest and dividends from other states’ obligations are added back;
• taxes measured by net income are added back;
• net operating loss carrybacks or carryovers are added back;
• dividends and royalties received from persons other than U.S. persons and foreign   operating entities may be deducted;
• royalty, interest, or other expenses paid to a related person for use of an intangible asset if the person is not included in the taxpayer’s unitary business group are added back;
• interest income from U.S. obligations may be subtracted; and
• for tax years beginning after 2011, income and expenses from producing oil and gas subject to the severance tax are eliminated. With the exception of the oil and gas income and expenses adjustment, these adjustments are substantially similar to those made under the MBT.

Additionally, a ten-year operating loss carryforward is available for losses created under the CIT. Loss carryforwards under the MBT system are not carried forward and are lost.

Apportionment

The CIT will use a single sales apportionment factor. Unitary Business Groups will include all sales in Michigan in the sales factor regardless if any of the entities have nexus in Michigan. Sales between members of a unitary group will be eliminated in the calculation of the sales factor. A taxpayer with direct or indirect ownership of a flow- through entity would apportion the business income that is directly attributable to the business activity of the flow-through entity by using an apportionment formula based on the business activity of the flow-through.

Credits

Taxpayers with gross receipts that do not exceed $20 million and with adjusted business income that does not exceed $1.3 million may claim a credit equal to the amount by which the tax exceeds 1.8% of adjusted business income. The credit is phased out based on a sliding scale for compensation ranging from $160,000 to $180,000. This provision is similar to one under the MBT. All other credits that were applicable under the MBT have been eliminated.

Corporations can elect to continue filing the MBT return if they have unused “certified” credits or credit carryforwards. Certified credits are credits granted before January 1, 2012 under the MBT Act. They include the Michigan Economic Growth Authority, Renaissance Zone, Brownfield Redevelopment, Film Production and Battery credits.

Taxpayers not subject to the CIT that have these credits can also elect to continue filing the MBT return in order to receive the credit. The election will apply to an entire unitary group, not just the entity with the credits.

The election is made with the first tax year ending after December 31, 2011. Taxpayers that make this election will not file a CIT return. Additionally, taxpayers making the election must continue to file an MBT return until the credit and unused credit carryforward is exhausted. While the MBT return is filed, taxpayers must still pay the greater amount of tax due under the MBT or CIT, after taking into account the credit. Taxpayers considering this election should plan carefully and consider future events that may impact their tax base.

Summary

The Governor believes the CIT is simpler and fairer than the MBT regime. The changes reduce Michigan business tax revenues by approximately 80 percent by eliminating the taxation of all business entities other than C Corporations. These changes will certainly be unpopular with most individual taxpayers in Michigan, given their tax liabilities are likely to increase. The goal of the legislation is to create jobs by reducing the corporate tax structure. Time will tell if these changes will help Michigan’s fragile economy.

By: William J. Barnes, CPA, CVA, MST

Michigan Governor Rick Snyder has recently signed legislation that will substantially revise the personal income tax by lowering the rate, reducing deductions and exemptions, eliminating credits, and changing withholding requirements. The changes are effective January 1, 2012 and are summarized below:

Tax Rates

Elimination of the phased reduction of the rate to 3.9%, replaced with a reduction to 4.25% beginning January 1, 2013. Accordingly, the current rate of 4.35% will now continue until January 1, 2013.   

Deductions Eliminated

Ø      Interest, dividend and capital gain deduction for taxpayers born after 1945

Ø      Deduction for political contributions

Ø      Distributions from certain IRAs used to pay qualified higher education expenses

Ø      Charitable contributions made from a qualified retirement plan

Exemptions

Ø      Current Michigan personal exemption amount of $3,700 is phased out for single taxpayers with household resources between $75,000 and $100,000 and for married couples filing joint returns with household resources between $150,000 and $200,000

Ø      Exemption amount of $3,700 is fixed through 2012 – beginning in 2013 the exemption will be indexed for inflation

Ø      Elimination of additional exemption for each taxpayer and every dependent who is 65 years or older

Ø      Elimination of the $600 exemption for dependent children under age of 19

Pension Changes

The deduction for pension benefits for senior citizens is curtailed based on the taxpayer’s birth year and household resources. Currently, this deduction is limited by a dollar amount, but no other limitation applies. Under the new law taxpayers will be classified into one of three categories:

1)      Taxpayers born before 1946 continue to have same treatment of retirement and Social Security income as in prior law, and may claim the personal exemptions for which they are eligible.

2)      Taxpayers born in 1946 through 1952 take an exemption of $20,000 for a single return and $40,000 for a joint return against retirement income until age 67 when they may take the same exemption against all types of income. These taxpayers at any age may claim personal exemptions for which they are eligible and may exempt Social Security income. However, the $20,000/$40,000 exemption is not available when total household resources exceed $75,000 for singles and $150,000 for joint filers.

3)      Taxpayers born after 1952 receive no exemption for retirement income until they reach age 67, except for the Social Security exemption. At age 67, the taxpayer has the following choices:

Ø      Exempt $20,000/$40,000 against all types of income – no additional exemptions for Social Security or,

Ø      Continue exemption for Social Security, along with personal exemptions for which they are eligible.

However, the $20,000/$40,000 exemption is not available where household resources exceed $75,000 for a single return and $150,000 for a joint return.

Credits

The new law also eliminates several of the non-refundable credits, including:

Ø      City income tax credit

Ø      Public contributions credit

Ø      Community foundation credit

Ø      Homeless shelter/food bank credit

Ø      Historic preservation credit

Ø      College tuition credit

Ø      Vehicle donation credit

Ø      Individual or family development credit

Ø      Adoption credit

Ø      Stillbirth credit

The new law also changes the Homestead Property Tax Credit – the credit is not available if the taxable value of the homestead exceeds $135,000. The credit is also not available for taxpayers with household resources above $50,000.

The credit is equal to 100% of the amount by which property taxes exceed 3.5% of total household income.

Withholding

Income tax withholding is required for persons who disburse pension or annuity payments. Also, every flow-through entity with business activity in Michigan that has more than $200,000 in business income after apportionment is required to withhold on the share of business income for each member that is a corporation.

These dramatic changes will certainly put more of the state’s tax burden on individuals, which is the Governors, intent.  The changes will also make tax compliance much more difficult.

By: Tom Mitchell

With the passing of the Patient Protection and Affordable Care Act of 2010 (A.K.A.“Obamacare”), many employers are concerned about the new Form W-2 health care coverage cost reporting requirements.  The following is a summary of the major points and provisions concerning those reporting requirements.

The amounts required to be reported will continue to be tax free.  Because the coverage costs are not taxable, the costs should be reported on Box 12 of Form W-2 using code “DD.”  This reported amount will not affect boxes 1 or 2 and are reported for informational purposes only.  It is also important to note that these costs are not required to be reported on Form W-3.

This reporting requirement is optional for all employers for the 2011 tax reporting period.  For the 2012 tax period, employers who filed 250 or more W-2 Forms in 2011 will be required to report the health care coverage costs on the employee Form W-2s.  Employers who filed fewer than 250 Form W-2s in 2011 qualify for transitional relief and do not have to report coverage amounts on their 2012 Form W-2s.  The relief for taxpayers that qualify for transitional relief is only temporary, and can change when the IRS publishes further guidance.

The next logical question is what costs are required to be reported for employers who do not qualify for transitional relief?  All aggregate reportable costs of coverage and any employer-sponsored coverage except Archer Medical Savings Accounts, Health Savings Accounts, and Salary reductions for flexible spending arrangements should be included if the amounts are paid by the employer and/or the employee.  Certain costs are excluded including: coverage for long-term care, Health Insurance Portability and Accountability Act (HIPPA) “excepted benefits”, dental and vision coverage, and specialized coverage if paid on an “after tax” basis.

Form more information on employer reporting requirements of health care coverage on Form W-2 please see the following sources:  Notice 2010-69 or Notice 2011-28 which can easily be found at www.irs.gov.