Quote:
Originally Posted by MikeNigh
I don't see how it is tax evasion considering you can't use the money for anything except for investing unless you first give it to yourself as a taxed salary. Corporations certainly don't salary out all it's gross income to the owner and pay an income tax on it before it turns around and uses it again. I'm not sure why your company should either, and am also not sure why entities should be forced to hire you directly and not your company.
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I'm not entirely sure that you understand the basics of how businesses are taxed. In overly simple terms:
You have an entity that has $1,000,000 in gross receipts (income). It has $600,000 in operating expenses. That leaves $400,000 of net income left over.
If that entity is a C corporation or an LLC that has elected to be taxed as a corporation, that $400,000 is taxed at around 35% (federal; we're ignoring all state taxes right now, but just assume that they follow federal at a lower rate). It doesn't matter if the corporation plans to spend that whole $400,000 to grow the business. They have to pay the tax. So they pay $140,000 in taxes, which leaves them with $260,000 of profit left. Now, the owners can work for the corporation and draw a salary, which is taxed to the individual like any other salary. Plus the corporation gets to take a deduction for the salary as an operating expense. But if the owner wants to draw earnings out of the corporation in excess of their wages, the corporation would issue them a dividend. This is often referred to as "double taxation" because the corporation already paid tax on that money, but the dividend is then also taxable to the owner. Meanwhile, the corporation does not get to take a deduction for the dividend.
To get around this double taxation, other types of entity were created, such as S corporations, partnerships, and LLCs taxed as partnerships. In these types of entities, all earnings flow through to the owners and are taxed on their personal income tax returns. In the original example, the company has $400,000 in profits. Now, it used to be that often the individual tax rates were lower than corporate tax rates, but now the opposite is often true, but we'll ignore that for now. Let's assume that the owners also have a marginal tax rate of 35%. So now that $400,000 flows through to the individuals. It doesn't matter that the business reinvests all of the profits and the owners get no cash; they still pay the tax. Someone has to. So now (assuming 4 owners at 25% ownerships each) each owner has paid $35,000 in taxes on the profits. The same $140,000 of tax was paid. But now the benefit comes in... if the owners want to take a distribution from the entity (not wages), they can take a distribution (similar to a dividend) but it is tax free. It reduces their basis in the stock of the entity (so they could potentially pay tax when they sell their ownership in the entity), but for this example you can assume that they have now effectively eliminated the "double taxation".
This is the type of tax benefit that different types of legal entities can provide. But as you should have noticed in all examples, the profits of the entity are ALWAYS taxed. It doesn't matter if the money is reinvested in the business. You still have to pay tax on your profits. So you either have to reinvest in deductible items to the full extent of your profits every single year before the close of the year (earn $1,000,000 and spend $1,000,000 on tax deductible expenditures in the same year), so that you net to a profit of zero or a loss, or you pay tax on your net profits. There's no way around that. There are specific strategies to help defer tax of certain transactions, or speed up deductions so that you pay less tax now, but potentially more tax later (time value of money).
But there is no legal way to avoid paying taxes. And certainly consult with an attorney and a CPA before entering into a tax avoidance strategy, as they could lead to large penalties and even jail time.
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