In recent years, the interest-charge domestic international sales corporation (IC-DISC) has been a popular tax-reduction tool for exporters. Without going into detail, one of the IC-DISC’s most powerful tax-saving tools is its ability to convert ordinary income into qualified dividends taxed at preferential rates. However, by lowering corporate and individual tax rates, and creating a 20% deduction for qualifying pass-through entities, the Tax Cuts and Jobs Act narrowed the differential between ordinary tax rates and qualified dividend rates, thus reducing the tax benefits of an IC-DISC. If you have an IC-DISC, now may be a good time to evaluate whether its compliance and maintenance costs justify the benefits.
Handle related-party transactions with care
Owners of related businesses must structure and document transactions between those businesses carefully or risk unwelcome tax consequences. One taxpayer learned this lesson the hard way in a recent U.S. Tax Court case. In that case, the owner of three S corporations used one company’s funds to pay its sister companies’ debts. Rather than document these transfers, the owner “treated legally separate corporations as one big wallet.”
Absent documentation or other evidence that the transfers were loans, the court concluded that they were capital contributions. What’s more, because the contributions benefited the owner by satisfying two of his other companies’ debts, they were constructive dividends and, therefore, taxable income to the owner. The court also found that the payments constituted wages for which the owner owed employment taxes.
These tax consequences likely would have been avoided if the owner had planned and documented the transfers more carefully. As the Tax Court observed, “Taking money from one corporation and routing it to another will almost always trigger bad tax consequences unless done thoughtfully.”
Watch out for S corporation stock in your trust
To qualify for the tax benefits of S corporation status, a company must satisfy several requirements, such as having one class of stock and no more than 100 shareholders. In addition, certain persons or entities are ineligible to be S corporation shareholders, including certain trusts.
If your estate plan includes one or more trusts that hold S corporation stock, be sure that they qualify as S corporation shareholders or else you’ll risk losing S status. Eligible trusts include grantor trusts, provided they have only one “deemed owner” who’s a U.S. citizen and meets certain other requirements; qualified subchapter S trusts (QSSTs) or electing small business trusts (ESBTs) that meet certain requirements; and testamentary trusts, provided they distribute the stock to an eligible shareholder within two years after receiving it or become QSSTs or ESBTs.