The Investment Scientist

Posts Tagged ‘small business

(I got this from Cal Klausner, a CPA friend of mine.)

Small Biz TaxAfter recent tax changes, owners of small businesses face a question: Should the business continue to function as an S corporation, or should the entity revoke its election under Subchapter S of the Code?

Despite a number of statutory constraints, conventional wisdom has generally favored an S corporation classification. An S corporation is a pass-through entity whose shareholders are subject to personal income tax based on the income of the corporation. A C corporation, by contrast, is taxed as a separate entity at corporate rates, and its distributions to shareholders are subject to the personal income tax. A small business corporation electing under Subchapter S may have no more than 100 shareholders, and may not have more than one class of stock. There are no similar constraints on C corporations. Nevertheless, an S corporation classification provides business owners a superior degree of flexibility and is therefore generally preferred. Specifically, by having its income flow directly to its shareholders, an S corporation is not subject to the double taxation that a C corporation may be unable to avoid.

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Captive Insurance

I went to a conference for CPAs last week, and my biggest takeaway was a concept called captive insurance.

This is the concept of a business owner setting up an insurance company to insure the risk of his/her own business. Thus the name captive.

But what’s in it for one to have one’s own insurance company?

Tax Mitigation

It turns out that Congress has created legislation to encourage captive insurance – some would call that a tax loophole. IRC 831(b) states that small insurance companies ($1.2m or less in annual premium income) pay tax only on investment incomes. In other words, they don’t pay tax on premium income.

Can you see the tax loophole here? If a business pays its captive insurance company $1.2m in insurance premiums, the premium is deductible to the business and yet tax exempt to the captive insurance company. Depending on the tax structure of the business, this could mean a tax saving of 40% to 70%.

But tax savings aren’t the only major benefit!

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As a small business owner, you are caught in a conundrum. On the one hand, you need to offer good health benefits to your employees to attract and keep talent; on the other hand, you can’t afford to lose an arm and a leg doing so.

There is a simple option that enables you to kill two birds with one stone—Section 125 Premium Only Plan (POP).

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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