Nevada Corporate Services

Question - 

I want to reduce my taxes as much as possible. I'm a self-employed psychologist in Massachusetts with one dependent pulling in around $70,000 per year? I've formed a personal corporation (PC) and would appreciate a plain English answer to my tax savings question. I am the corporation's only employee (president, secretary, etc.) and operate out of my home.

Answer -

PC is a term used for Professional Corporation, not personal corporation.

A Professional Corporation is subject to a 35% flat tax, and limits the owners to people licensed in the specific field. As a psychologist starting a PC for your practice, you could not have non-psychologist owners.

A Sub-S corporation is a normal corporation that files one additional document (Form 2553) and declares that it will be taxed as a "pass-through entity". As pass-through entity all of the profits will be attributed to the owners and they will pay taxes personally.

Right now you are doing business as a Sole prop, and are filing a Schedule C with your 1040 form.

I have charted out the personal tax rates below:

As you can see the lowest tax bracket is really pretty high. And you are probably close to the 50% bracket on your top income dollars. Yes, you get some deductions, but not very many. Right now you are operating in the highest taxed business entity as a sole proprietor. Doing business as a PC your tax savings would include:

Any money not taken as wages/salary is not subject to social security, Medicare, workers comp, unemployment, local income or payroll taxes. The Corporation would, however, pay a flat 35% federally and any local corporate tax (I believe Mass. is almost 8.0%). You would also have the ability to take fringe benefit deductions, such as 100% medical reimbursement (personally you can not deduct all of your medical expenses, if the corporation pays for them, they can be written off so there is no tax due on those payments, it is like getting a 50% discount, since you get to spend the government's money too).

If you do business as a Sub-S you pay personal income taxes on all of the money, get no employee fringe benefits. But you save a portion of the Social Security and Medicare taxes. The Sub-S allows you to split your income between "Earned" (subject to payroll taxes and income taxes) and "Passive" (subject only to income taxes). Conventional wisdom suggests that 50% of your income can be passive in a Sub-S, so we effectively save 1/2 of the payroll taxes, or 7.65%,under these parameters.

This scenario applies since your income is at $70,000. However, as your income exceeds the social security cap (97,500 for 2007) your savings decrease. If you earn twice the Social Security cap your savings drops to 1.45%; since all of the SS has been paid and leaving only the Medicare portion.

Of course, it will depend on exactly how you spend and save your money, to precisely determine your exact savings. However, it breaks down something like this:

Sole proprietor: highest possible tax, no deductions.

Sub-S: savings of part of payroll taxes, not many deductions.

PC: Potentially a larger payroll tax savings and better deductions, but with a high base tax that probably exceeds your personal rate based on your present income.

Your savings as a Sub-S: $5355 (70k x 7.65%) But your total taxes would still exceed $25,000.

None of these will get you retired in the next three years.

I would offer you one further option that will drastically reduce your taxes, maximize your deductions, reduce your likelihood of an audit and be easy to manage.

Continue doing business as you are but increase your expenses so you have little or no net profit. This means you pay little or no net tax. If that added expense is paid to a corporation that is not licensed in the field of psychology, it would be taxed at 15%; not the flat 35%. This corporation would provide all of your fringe benefits, including paying for education for you and your dependant (even private school). If that corporation operates in Nevada there's no state income tax to pay. This results in moving you from close to 50% in taxes to less than 15%. That is going to be significantly more money.

Call us and we will go into further detail.

Here is direct answer from the IRS site that applies:

Can you give me plain English definitions for the following: (1) a closely held corporation, (2) a personal holding corporation, and (3) a personal service corporation?

Generally, a closely held corporation is a corporation that, in the last half of the tax year, has more than 50% of the value of its outstanding stock owned (directly or indirectly) by 5 or fewer individuals. The definitions for the terms "directly or indirectly" and "individual" are in Publication 542, Corporations. Generally, closely held corporations are subject to additional limitations in the tax treatment of items such as passive activity losses, at-risk rules, and compensation paid to a corporate officers.

A personal holding company is defined in Internal Revenue Code section 542. Basically, a corporation is a personal holding company if both of the following requirements are met:

·                     Personal Holding Company Income Test. At least 60% of the corporation's adjusted ordinary gross income for the tax year is from dividends, interest, rent, and royalties.

·                     Stock Ownership Requirement. At any time during the last half of the tax year, more than 50% in value of the corporation's outstanding stock is owned, directly or indirectly, by 5 or fewer individuals.

Refer to the Form 1120, Schedule PH Instructions for more information and a list of exceptions.

A personal service corporation is a corporation where the main work of the company is to perform services in the fields of health, law, engineering, architecture, accounting, actuarial science, the performing arts, or consulting. Examples may be law firms and medical clinics. Also, substantially all of the stock is owned by employees, retired employees, or their estates.

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