corporations must use a calendar tax year unless the corporation establishes to the satisfaction of the Internal Revenue Service that it has a business purpose for using a fiscal tax year, or makes a Section 444 election. S Corporation. S corporations must use a calendar tax year unless there is a business purpose for using a fiscal tax year and the Internal Revenue Service approves. If the S corporation cannot establish a business purpose for using a fiscal tax year, it may be eligible to make the Section 444 election described above. The corporation uses the same tax year for both federal and Minnesota tax purposes. Compensation for Services A business may use a variety of methods to compensate persons who provide services to it. Some of these methods include salaries or wages, personal draw, cash for services, and property for services. This section discusses the tax consequences of compensation for services provided by the owner of the business. Compensation to non-owner third parties, including the spouse or children of a sole proprietor, generally will be a deductible expense so long as compensation is reasonable and the services are necessary to the business. Sole Proprietorship . A sole proprietor is not considered an employee of the business and does not receive wages or salary for tax purposes. A sole proprietor is subject to tax on the net income of the business as it is earned, regardless of whether it is withdrawn. Compensation for services or other amounts withdrawn from the business thus are considered withdrawals of income and are not again taxed at the time of withdrawal. Partnerships. Like sole proprietors, partners of a partnership are considered to be “self-employed” and, as such, are not considered employees of the business and do not receive wages or salary for tax purposes. Amounts paid for services in a manner similar to salary or in the form of benefits that are not determined with respect to partnership income are taxed as “guaranteed payments” – ordinary income to the partner and deductible or capitalizable by the partnership depending on the nature of the payment. The partners also are subject to tax on their share of partnership income as it is earned, regardless of whether it is withdrawn. In the case of partners treated as “general partners” for federal income tax purposes, these amounts may be considered income from self-employment and may be subject to the tax on self-employment income. Typically distributions made to partners are not taxable unless they exceed the partner’s basis in his or her partnership interest. C Corporations. Payments to owners: Payments to shareholder-employees in the form of salary or wages are deductible by the corporation in determining taxable income. As with other wages and salaries, these payments are taxed to the recipient as wage or salary income. Payments must be reasonable and the services must be necessary to the business. Compensation to shareholder- employees which is found by the Internal Revenue Service to be unreasonable may be reclassified as a dividend. This is to prevent using salary payments as a device to reduce corporate profits subject to tax. S Corporations. Payments to owners: The payment of wages or salary to S corporation employees, including owner-employees, is deductible by the corporation in determining taxable income. These payments are then taxed to the recipient as wage or salary income. Payments must be reasonable and the services must be necessary to the business. The question of unreasonably large salaries to shareholder-employees of S corporations is not as important as
25
Made with FlippingBook - Online Brochure Maker