My father has some wild ideas. He says our family could form a corporation and call our cars, homes etc corporate assets.
(he also believes every U.S citizen is traded on the NYSE and the USA is a “Corporation”.)
He could, but the corporation still has to pay for them, Where does it get the money? A corp has to have revenue of its own to make what he is thinking work. I assume he thinks he can transfer a car to the corp then the car payments/house payments are magically tax deductible, well they are for the corporation, but not for him personally.
It dont work like he is thinkin.
Drach
CEO of a CA corporation
Your father is correct. There is nothing to stop your family forming a corporation in which family members are the shareholders, and transferring all your assets to the ownership of that corporation.
There is no reason to suppose that this would result in any tax advantages for your family members, though.
He expanded on his theory. He says the family can form a corporation and say invest in stocks, and buy automobiles and they could be considered corporate assets and tax breaks. As long as the family is in a “business” they can get corporate benefits.
I’m sitting here laughing. I told him his idea sounds like the last thing a person says before they are led away in handcuffs for tax evasion. But I don’t know the law. His idea is that if a family member was gonna buy a car anyway, mileage and such would be tax deductible. Of course it would be ‘owned’ by the corp., but that wouldnt matter. I’m imagining him writing off a trip to the beach for the family vacation as a ‘business expense’ or something.
Is there anything remotely accurate about what he proposes?
I think his idea is that the “revenue” is each members paycheck from their day job.
Which is still going to be individually taxable before it goes into the corp. Putting money into a corporation does not make it untaxable, it just makes it given away.
Only way your father is gonna get this to fly is if they already have a metic buttload of money and the corp is holding the investments. Then investment returns are income to the corporation, the corp uses those revenues to pay its bills (house and car payments, electric bill, cable, food, etc)
Problem is, using corp funds for personal use is a big no-no. If he wants cash in his pocket, the corp has to pay him (generating taxable payroll transactions)
He could try to pretend he is a consulting service that only accepts cash. That will go over at the IRS like a fart in a spacesuit when audit time comes around.
Just a direct bubble burst here.
The company can take either standard mileage OR pay vehicle related expenses (fuel, insurance, repairs, payment) not both.
Nothing to stop your family capitalising the corporation, and the corporation using the capital to conduct an enterprise of investment (or anything else). The income from the corporation’s trade is taxable to the corporation.
The expenses of generating the income are deductible to the corporation. However if the corporation provides cars for the persona use of stockholders, pays stockholders fuel bills, utilities, provides houses to stockholders, etc, this has nothign to do with the generation of the corporations income. These expenses will not be decuctible to the corporation.
They will, I suspect, be assessable to the stockholders as a return (in kind) on the stockholder’s investment in the corporation; they are basically stock dividends paid in kind rather than in cash.
The very basic principal that your father needs to cease to misunderstand is that corporate expenses are almost always tax deductible because corporations almost always incur expenses in the context of an income producing business. It is the latter (the nature of the expense) that makes the expenses tax deductible, not the corporate nature of the payor.
Your father is engaging in cargo cult thinking. He thinks if he adopts a particular superficial form, a substantial result will be obtained. He thinks this because he has noticed that others who use that superficial form have achieved that substantial result. He doesn’t understand that the form is merely that, and it is an underlying substantial cause that achieves the result, not the superficial form.
My family were the sole stockholders of a corporation for 20 years. It had no great financial advantages other than it provided the means of generating greater income than available conventional employment would have. Has conventional employment been available that would have provided the same level of income, it would have been preferable in a variety of ways. Among other things, it’s no fun having your own personal IRS agent. I’m sure plenty of people skate by under the radar, claiming deductions for fictitious business purposes, but if your income reaches a certain level, you will be scrutinized.
I’ll also add:
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Many states have a base tax that all corporations have to pay (in California, all corporations have to pay a minimum of $800 each year, regardless of income). Furthermore, there are cities and counties that have a gross receipts tax. You really have to look at your projected income and your projected cash flow to determine whether it makes sense to incorporate. Of course, there are other reasons to incorporate independent of tax issues.
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If your Dad is an employee of another company (that is, he gets a W2 at the end of the year), then that income is not going to go directly into the company. It’s going to go to him, and all the taxes that get deducted from his paycheck are still going to get deducted from his paycheck. Some employers will pay a person’s corporation directly (usually for things like consultants), but my personal experience is that large companies hate doing this, and if they do it, they will make you incur a number of additional expenses (such as workmen’s comp and liability insurance).
Now, if he has a pass-through corporation, corporate losses may be deductible on his personal taxes, so it could be beneficial. But it also might end up being worse or it might not make a difference and end up making him spend a lot of time for nothing. It can be very specific to the circumstances.
Finally, owning a corporation can be a big hassle unless you are prepared to deal with a lot of accounting and tax issues yourself (or hire someone to deal with them). I have a few corporations, and I spend quite a bit of time dealing with a lot of paperwork.
Actually it’s a common way for rich people to avoid tax, at least in Britain. Set up My Name Ltd., then get your employer to contract for your services with the corporation rather than with you personally, so the money doesn’t go through you between employer and corporation. Corporation tax being lower than the top rate of income tax. Then receive the money from the corporation through a Jersey trust or some other explicitly tax dodging endeavour. But you have to be rich, to afford the incorporation and the lawyers and the accountants and the annual meetings in Jersey, and to get the company you work for to do it. Might also be technically illegal, which doesn’t stop people doing it.
I’d agree with this except I’d remove “if your income reaches a certain level.” (Mind you, they were nice, and they did catch a couple of genuine mistakes, in our favour.) Becoming a corporation was necessary for our household.* I wouldn’t repeat the experience, though, and it was a major pain. Plus you’ll need to retain an accountant, which isn’t free, and file taxes quarterly, which isn’t fun, and annually with your city. Between the accountant and paying employment taxes, it cost more than it saved in our case. Not worth it.
*Boring immigration / visa reasons: easier to create a business around an individual’s skills than to change the 1996 DoMA or wait for gay immigration.
ETA: I forgot about the $800 / year in California. It’s “estimated tax,” but if you owe less at the end of the year, you don’t get it back. Our corporate income was so low we never paid income tax, that’s true. We did pay thousands in other taxes, though, like the employment tax I mentioned and the $800 BrightNShiny mentions.
Actually, it’s even worse than that.
Corporations cannot take the standard mileage rate. They can only reimburse at up to the standard mileage rate. In order for this reimbursement to avoid being considered (and taxed) as payroll, the mileage (and its business purpose) must be documented.
But it can deduct actual expense right? Absolutely, provided that the personal portion of actual expenses (as determined by documenting business-purpose and personal mileage) is considered (and taxed) as payroll to the driver.
And in a corporation that earns income only from investments, the business purpose is going to be virtually nothing. I suppose trips to the bank and the investment advisor will count.
So… what was gained? The company gets a tiny write off for business miles… and pay 15% MORE in taxes on the rest of the cost of the cars. (Actually, it’s more than 15% if you add in federal and state unemployment costs.)
Isn’t there some advantage of incorporating a family in regards to inheritance? Say someone with a large farm or ranch that would have to be divided up amongst the kids and parts sold to pay inheritance taxes? They could incorporate it with the parents maintaining control until death and the kids inherit the parents shares while keeping the farm whole?
I think I have also heard this advice given to people coming into a large sum of money such as a lottery winner. Say you win the lottery and take the annual payouts over 20 years. If you claim it as a person the payments are only to you, so if you die before getting it all, the payments stop, but if you set up a corporation with the family and claim it that way, the corp would continue to recieve the payments until complete.
Family businesses form corporations all the time. What your father is overlooking is that:
a) they’re actually businesses, i.e., providing goods and/or services that other people want to pay for, and
b) the business pays its taxes, then it pays the family members, who then pay their own taxes.
The gummint doesn’t magically not get money just because I get paid by Kuniloucorp instead of Megacorp.
Corporations, partnerships and trusts can all be set up to achieve this kind of objective. How well (or if) it works depends a lot on circumstances.
Anyway, the goal is not to have the kids inherit the stock. The goal is to gift the stock at some early date when it isn’t worth very much so that the kids inherit nothing.
For example, the family farm is worth $1 million in 1970 when the parents form a corporation and give 20% ownership stakes to 5 kids. Because $1 million in gifts is under the gift tax exclusion, no tax is paid by them at that time. The parents are corporate officers, so they take a salary from the farm and control its operations. When they die in 2010 (OK, bad example, there was no estate tax in 2010 - so they died in 2009 or 2011), the farm is worth, say, $20 million. Instead of paying $6+ million in estate taxes, they owe nothing because the dead parents didn’t own the farm. The 5 owners of the farm are still alive; their stock has appreciated, but they’ll pay no tax until they sell the stock.
In a slight defense of the OP’s dingbat Dad …
Back in the 1960s & early 70s, the top rate of US personal income tax was pretty high. While the top rate of corporate tax was pretty low. And there were a lot of “loop-holes” and lax enforcement which made it both easy and advantageous for high-income or wealthy folks to form family corporations. And to do things like pay little Billy, who is only 8 years old, $50K / year for “consulting services” to the family with no questions asked by the IRS.
Fast forward to even the 1990s, much less today, and the situation has changed completely. The top rate of personal income tax is now lower than the top rate of coprorate tax. Various capital gains have advantageous tax treatment compared to either corp or personal ordinary income rates.
And almost all the “loop-holes” which let people legally get away with treating personal expenses as business expenses have been closed. As well, enforcement for violations of the new tighter rules is much more robust than it was in the 1960s.
My bottom line: The OP’s Dad’s idea wasn’t totally whack-job crazy back in 1965. It is now. And it was never advantageous for ordinary schlubs with ordinary jobs.
Thanks for the correction and clarification. I knew it was something along those lines.