Case Studies

This portfolio of case studies will show you the kind of problems we deal with and the results we get. See the individual case studies after the listing.

Case Study #1 - Benefits of Tax Planning - Planning Turns Taxable Income into Tax Free Income

Case Study #2 - Benefits of Tax Planning - Planning Saves Taxpayer $18,000 in One Year

Case Study #3 - If You Are Audited! - Intervention Prevents Tax Audit Problems

Case Study #4 - One Example of What Can Go Wrong In A Tax Audit

Case Study #5 - An Example of What Can Go Right In A Tax Audit

Case Study #6 - An Second Example of What Can Go Right in A Tax Audit

Case Study #7 - A Third Example of What Can Go Right in a Tax Audit

Case Study #8 - How Planning Can Save Tax Dollars for Owners of Closely Held Corporations

Case Study #9 - Do You Want To Know How You Can Control Your Corporate Tax Situation?

Case Study #10 - Planning Helps An Incorporated Professional Put Away Money For Retirement And Save Payroll Taxes

Case Study #11 - How A Corporate Owner Can Lease Property to Their Corporation and Save Payroll Taxes

Case Study #1 - Benefits of Tax Planning
Planning Turns Taxable Income into Tax Free Income

One of three owner/employees of a corporation needed to take a disability retirement because of a heart condition. Their corporation was providing disability insurance for the three owner/employees. Any disability benefits received by the owner/employee under this arrangement would be taxable. Fortunately, before he retired on disability they consulted me. We were able to change how they handled the insurance so that the benefits paid were tax free.

Lesson Learned:

The owner/employee retired on disability, and the monthly payments that he now gets every month are tax free- putting several thousand dollars in his pocket each year that would have otherwise gone to the Internal Revenue Service and the Franchise Tax Board.

Case Study #2 - Benefits of Tax Planning
Planning Saves Taxpayer $18,000 in One Year

I have a client who is on a roll. He is self employed, his services are in demand, and he is making a good income.

During November we did some tax planning. We estimated what his income and tax obligation for the year would be. He was going to owe considerable tax. He is still young and not overly concerned with retirement at this time. But, when I showed him that he would save $18,000 in taxes by making a $40,000 contribution to a retirement plan his interest picked up. And that is only part of the story. The $40,000 contribution to his retirement plan would actually only tie up $22,000 in cash after taking into consideration the $18,000 tax saving. This $22,000 after tax investment will grow to approximately $170,000 when he retires in about 30 years, figuring a conservative 5% annual return on the money.

Lesson Learned:

Plan now to save taxes and provide for a secure retirement.

Case Study #3 - If You Are Audited!
Intervention Prevents Tax Audit Problems

Hopefully you will never have to deal with the letter from the Internal Revenue Service that says they want you to appear for a TAX AUDIT. But, the fact is the IRS is getting ready to launch a more aggressive audit program.

Having a professional help you with a tax audit is a wise move. Tax laws are complex and confusing, especially if you are operating a business. A taxpayer can inadvertently make an inaccurate statement or improperly describe a transaction to an IRS auditor sending them on a fishing expedition and/or causing an improper assessment of additional tax. There is an old saying that says: An ounce of prevention is worth a pound of cure. This is ever so true if you have to deal with the dreaded IRS AUDIT. Having someone to represent you who knows the ins and outs of the tax rules and IRS procedures helps you present the correct picture to the IRS and prevent unnecessary aggravation and expense. It is much better to prevent the IRS from assessing additional tax in the first place than it is to get them to reverse it on appeal. Once the momentum gets going, it takes can be impossible to reverse an assessment.

Case Study #4
One Example of What Can Go Wrong In A Tax Audit

The IRS was auditing my business client who had some quite complicated transactions and lots of records. The IRS was in my office for a couple of weeks. The IRS auditor discovered some bookkeeping errors, about which the taxpayer was unaware, that caused an underpayment of tax. The taxpayer employed a bookkeeper and used the latest in computer bookkeeping systems, but nevertheless these errors did happen even though the taxpayer did everything within their control to prevent them. The taxpayer quickly agreed to pay the additional tax owed due to these errors.

The IRS auditor was asking my client some questions about his business when he inadvertently mentioned a real estate transaction that occurred in a prior year. I wanted to tell him to just stick to the questions the IRS auditor was asking, but the cat was out of the bag, so to speak. Well, to make a long story short the IRS auditor became interested in this old real estate transaction. Most real estate transactions are rather straightforward and this is what IRS auditors are used to seeing. But, unfortunately, this transaction was not straightforward. I had just completed a course on real estate so, I could understand what was going on and see why the IRS auditor might be suspicious.

Tax laws and business transactions can be complex so I understood the need to educate the IRS auditor about what was going on. Despite my efforts to explain, the auditor insisted on treating the transaction differently and assessed more tax. Well, I believed that the IRS would eventually understand this complex transaction and reverse the additional tax assessment. A conference with the field auditor's supervisor was not successful so I put my hopes on the appellate conference where there would be someone with more authority. I still had faith that the IRS would see the error of their ways.

At the appellate conference there was an IRS attorney and an IRS appellate officer who told me that she was experienced with real estate. To my amazement they still insisted on misinterpreting the transaction. A phrase came to my mind during the meeting, "I have my mind made up; don't confuse me with the facts." It seemed like the IRS was circling their wagons and would not be swayed. The key dispute was the ownership of a piece of real estate. I showed the deed to the property to the IRS officer as proof that the ownership of the real estate was real. She told me, "That is just a piece of paper." I said, "Yes that is just a piece of paper; a piece of paper that transfers title to real estate in California. And by the way, the Internal Revenue Code is also just a piece of paper." She was still unconvinced.

Well, there is a happy ending to this story. The IRS persisted despite the fact that all the evidence showed they were wrong. Their position was that, even though they were wrong, we had to prove it. The taxpayer appealed the tax assessment to the United States Tax Court which agreed with the taxpayer and reversed the IRS tax assessment. Unfortunately my client spent several thousand dollars in the process.

Case Study #5
An Example of What Can Go Right In A Tax Audit

Another client of mine received a notice from the IRS that they wanted to visit him in a couple of weeks. First I called the auditor and rescheduled his visit to give my client time to gather the requested documentation. I insisted that they locate their corporate minutes (which I had encouraged them to prepare each year). One of the best forms of audit protection for a closely held corporation is to keep proper minutes to fix the tax treatment of transactions which the IRS might tend to treat differently if there is no documentation - especially those involving officer/shareholder compensation and fringe benefits. If there is no documentation, the IRS will fill the void by defining the transaction in a way that results inevitably in more tax.

The IRS auditor was in my office about a week. I was able to develop rapport with him so we could meaningfully discuss some of his concerns about my client's transactions. The auditor agreed that no additional tax was due except with respect to one item-an item where the client failed to properly document a transaction which allowed the IRS to arrive at their own interpretation. The owner/stockholders had held a board meeting out of town (documented in their corporate minutes) which was a proper business expense. However a couple of the clients took their children. The IRS auditor disallowed the deduction for the children. He figured the disallowed deduction for the children based on the average cost of the trip for everyone. However, we all know that it costs much less for a child to stay in a hotel room and eat than for an adult. If my client had deducted the actual additional amount they paid for the children it probably would have been much less than the amount the IRS auditor disallowed. It was difficult to argue with the auditor because the client did not make any determination of how much it actually cost to take the children. The IRS did not question the trip-it was properly documented as a business trip in the corporate minutes and there were records of the business that was conducted at the meeting place. However, they left a void as to how much it cost to take the children; and the IRS filled the void in a way which resulted in more tax than if the taxpayer had done it themselves. Overall, a successful audit because this was rather minor in the whole scheme of things.

Case Study #6
An Second Example of What Can Go Right in A Tax Audit

Another person became a client after she got a letter from the IRS asking that she show up for an audit appointment. When I looked at the documents she had on hand to support her claimed business deductions for her small home-based business it was obvious that she wasn't aware of what records she needed. She was surprised when I explained to her what was needed and that if she didn't have the records, the deductions would probably be disallowed and additional tax assessed. An extension gave her time to gather adequate records. When I finally met with the IRS auditor I was able to answer all of his questions, and guess what- he found that my client had failed to take a deduction and issued a small refund!

Lesson Learned:

Know what records you need to keep, keep them, and have them organized and ready to go.

Case Study #7
A Third Example of What Can Go Right in a Tax Audit

A client who is a plumbing contractor in Southern California, received an IRS audit notice. Well, the client's bookkeeper just wanted the auditor to come out there and get it over with immediately because they had "nothing to hide." As you can see from the previous case studies, having nothing to hide does not keep the IRS from assessing more tax. So, I insisted that the IRS play by their own rules. Those rules say that the audit shall be at the place where the business records are located which was in my office. They did not want to transfer the audit to my office because the three year statue of limitations was about to expire. However, their own rules, written by Congress, required that they do so. When the IRS asked for an extension of time I had to decline because extending the time merely for the convenience of the IRS was not in the client's best interest. The IRS settled on copies of a few records which we gladly provided and a few months later issued a no-change audit report.

Lesson Learned:

If the IRS wants to make up the rules as they go along, it will be only for their advantage. Don't let them do it!

Case Study #8
How Planning Can Save Tax Dollars for Owners of Closely Held Corporations

First, let me give you a little background on corporations. Corporations are entities created by state legislators. They have no separate existence apart from the statutes that created them. Corporations are treated as independent entities (persons) for legal and tax purposes. They are separate from their owners and should be treated that way.

Many people incorporate their business because of the limited liability protection that the corporate form of organization gives them or if they want to sell shares in it to other people. It's also important to know that many of the tax rules for corporations are different than the tax rules for individuals. Creating a separate corporate entity creates tax opportunities and pitfalls. Corporate tax law can get quite complex so I'll limit my discussion to those corporations taxed as traditional corporations-Subchapter "C" corporations. Subchapter "C" refers to a section of the Internal Revenue Code. There are also Subchapter "S" corporations which are taxed much like partnerships. Limited Liability Corporations and Limited Liability Partnerships can elect to be treated for tax purposes as sole proprietorships, corporations, or partnerships depending on the number of owners they have and the tax elections they make.

Incorporation may provide tax benefits, but they also require more sophisticated tax planning and they need to comply with formalities in order to minimize taxes and protect against pitfalls. Many owners of closely held corporations do not appreciate the benefits of tax planning and the importance of documenting the corporate activities. They do not realize that they risk paying too much in taxes and losing the limited liability benefits of the corporation if they do not strictly adhere the corporate formalities.

The IRS gives corporations tax benefits not available to sole proprietorships and other forms of business. The following tax benefits are each possible depending on your particular situation. Again, these are only Subchapter "C" corporations. In general, the overall goal is to minimize the total tax burden of both the corporation and the individual owner.

Income Shifting-The ability to divide income between the corporation and its shareholders. Profitable small businesses that need to accumulate capital for business operations or expansion may benefit by accumulating income that is taxed at lower corporate tax rates than the owner's personal tax rates.

Fringe Benefits-A corporate fringe benefit is tax free income. The person who gets the advantage of the fringe benefit doesn't have to report income and the corporation gets a tax deduction. Corporations can deduct fringe benefits paid to owner/employees whereas sole proprietorships, "S" Corporations, and partnerships cannot. For instance, corporations can pay medical insurance premiums for their owner/employees. They can also set up retirement plans and medical reimbursement plans to pay medical expenses not covered by medical insurance.

Leasing Assets To Your Corporation-Leasing personally owned property such as real estate and equipment to your corporation can provide tax savings for many individuals.

Payroll Taxes And Self-Employment Tax Savings/-If your business is organized as a corporation and you're an owner/employee you'll take a salary from the corporation. The salary is subject to payroll taxes at approximately 15%-the corporation pays ½ of the payroll tax and the individual employee pays ½ of the payroll tax. If your business is organized as a sole proprietorship you pay self employment tax of approximately 15% of your business profits. But it really doesn't matter whether the corporation or the individual pays the payroll tax; ultimately the same amount of money goes to the government. The individual and/or his wholly owned corporation are the poorer. I will show you how you can avoid both of these taxes.

If your business is organized as a corporation, you can often arrange things so benefits come to you in a form other than salary. Thus you save about 15% in taxes. This is money in your pocket, not the government's. For example, if the owner leases property, like real estate or equipment, to the corporation, the income the owner gets is not subject to payroll taxes or self-employment taxes. Also, the corporation can pay medical insurance premiums or reimburse for medical expenses without paying payroll taxes on this benefit.

Case Study #9
Do You Want To Know How You Can Control Your Corporate Tax Situation?

I have several clients whose businesses are set up as corporations. Well before the end of each year we take a look at their gross income and expenses and estimate their tax liability for that year-if things go along without making any changes. We look at what they can do before the end of the year to minimize their combined personal and corporate income tax. Such as:

• increasing the owner/employee's salary if they were paid less than the actual value of their services to the corporation during the year,
• paying bonuses to unrelated employees,
• purchasing equipment and supplies before the end of the year instead of waiting until next year, and
• contributing to pension plans.

After looking at the alternatives, they decide which options are best for them and a plan is formulated and implemented with full knowledge of the tax consequences.

Case Study #10
Planning Helps An Incorporated Professional Put Away Money For Retirement And Save Payroll Taxes

An incorporated attorney wanted to retire in about four years. She was able to put most of her profit away for retirement by setting up a defined benefit pension plan. She was able to make tax deductible contributions that reduced the corporate taxable income to almost nothing after she took a modest salary. The corporation had very little tax obligation each year because of the pension plan contribution.

If the corporation didn't have the deduction for the pension plan contribution, then she would have had to take a much higher salary-salary which she would have had to pay payroll tax on (at about 15%) plus income tax each year. She was able to avoid the payroll tax and put-off paying the income tax until she takes the money out of the retirement plan in the future. She saved about $65,000 in payroll taxes in the four years-money which she was able to put away for retirement instead of giving it to the IRS.

The pension benefits which she is now receiving are subject to income tax but she permanently avoided the payroll taxes. A savings of about $65,000. Plus, the earnings on the pension contributions are not taxable until withdrawn.

Lesson Learned:

Take advantage of tax incentives to slash taxes and provide for retirement.

Case Study #11
How A Corporate Owner Can Lease Property to Their Corporation and Save Payroll Taxes

Several of my clients lease property to their corporations. Lease payments the corporations make are deductible by the corporation and the lease income the owners receive is taxable income, but it is not subject to payroll tax. The lease payments reduce corporate income and taxes on it. The lease payments also reduce the salary the owner/employee can take out-salary which would be subject to payroll tax. And, the lease income the owners receive is not subject to either payroll taxes or self employment tax. Again, this is a win/win strategy that saves 15% in taxes. Just by having the owners purchase the property instead of the corporation.

Lesson Learned:

Organize your activities to take advantage of the most favorable tax rules. You can save tax dollars!

Frederick A. Thompson, CPA an Accountancy Corporation (650) 343-5965   •   email: 1200 Dore Avenue, Suite 202, San Mateo, California 94401-1214

Copyright © 2006-2008, Frederick A. Thompson, CPA, an Accountancy Corporation. All Rights Reserved.
Professional Web Site Design by SunStar Media.