Boring tax post.
Most of the businesses I work with don't operate on a cash basis (recording transactions when cash actually changes hands), they recognize income and expenses as they're incurred (the accrual method). So, when earlier I talked about C corporations that are closely held avoiding corporate income tax by paying bonuses to their owner(s), they can be in situations where they don't actually have enough cash on hand to pay the bonus. (To avoid paying a few thousand dollars in corporate income tax, you end up paying much more than that in a bonus given the fact that the statutory corporate tax rate isn't 100% of taxable net income.
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Quite an awkward situation, to be a deadbeat like that. So how do you handle it? Why your owner(s) loan the bonus(es) back to the company without ever taking the cash personally, of course! "Well what do they get out of that?" you might ask. (After all, the wage income is still taxable to the owner(s) in the current year even if they haven't actually received the cash.) Why they get interest on their loan, and they now have a conduit to more easily extract taxable income from the C corporation. (You don't pay payroll taxes on interest income like you do on wage income, and interest expenses are deductible for corporate tax purposes, even nonsensical interest expenses like these.) And while the owner(s) have now essentially turned their business into a bank, they aren't paying themselves interest that they might expect to get at a bank on their completely unnecessary loan, in my experience they pay themselves between 5 and 8 percent interest. At this point I'd just like to give you a friendly reminder that legally speaking, this C corporation is treated as a distinct legal person from its owner(s) even though it's clearly their plaything. Well unless it means the C corporation has to pay for birth control, then suddenly it's an extension of the religious beliefs of its owner(s).
This is one front in the silly game of tax accounting wherein you don't really spend your time accurately reporting to bring companies into compliance, you spend your time setting up, tracking, and recording the various methods in which owner(s) extract money out of their C corporation to avoid paying corporate income tax.
Let's talk rent. A business has to be somewhere, right? For a larger business, rent can be quite an expensive fixed cost given that commercial real estate isn't necessarily in sync with residential real estate. So, you'd think that if the opportunity to buy its location ever presented itself, a business would jump at the chance to do so as to relieve themselves of this fixed cost. (Despite what a marginal utility adherent will tell you, reducing costs is also a way to create profit... not to infuse this post with a bad case of the Marxiness.) Well my friend, you'd be wrong. The owner(s) still buy the property mind you, but they buy it through another legal entity that they just happen to own (usually a pass-through entity) and the core C corporation still pays rent. Now the owner(s) have yet another conduit to extract taxable income from the core C corporation (like the nonsensical interest above, this rent expense is also treated as being completely legitimate for tax purposes), and it just so happens to be one that also isn't subject to the same payroll taxes as wage income. My what a coincidence of events!
The 3.8% Medicare tax on individual net investment income that was included in the Affordable Care Act made the sort of people who engage in these activities detailed above quite angry, you can imagine. Almost as much as poor people being able to see a doctor without facing financial ruin.
Almost.Be sure to join us next time wherein I show you just how absurd a large corporation can become when it tries to extract as much taxable income from itself as possible.
