In the past, tax planning for a closely held company often meant paying year-end bonuses equal to the corporation’s taxable income. After deducting the bonuses, any corporate tax liability would be wiped out, and double taxation would be avoided.

However, consistently “zeroing out” corporate income may attract IRS attention, and using bonuses to eliminate corporate income isn’t necessarily the best way to minimize taxes for the owner-employee.

Here’s another reason it may not be wise to end up with no corporate tax. According to the general rule for corporate estimated taxes, the IRS won’t charge a penalty as long as a company pays current-year estimated tax of at least the amount that was owed on the preceding year’s return. However, this “safe harbor” is available only when at least some tax was owed for the prior year. If a company shows zero tax liability in a given year, the next year’s estimated payments must equal 100% of the expected tax liability for that year. So you might want to plan corporate income and deductions to always show at least some taxable income and some tax liability.

Example: Your corporation will incur a small operating loss this year. Next year is likely to be more profitable, with projected income tax of $100,000. That means the company must pay quarterly installments of $25,000 each. However, with tax planning, if your company had $10,000 of taxable income this year, this year’s tax bill would be $1,500 (15% of $10,000). Next year, you would be required to prepay a total of only $1,500, reducing your quarterly installments to $375 each. The balance of your taxes would be due on the filing date for next year’s return, but in the meantime, you have the use of your cash.

Note: Rules differ for large corporations. For assistance with the tax planning for your closely held company, give us a call.