Trusts are great for establishing and maintaining privacy, but they either have no tax effect at all, or can be taxed at the highest rates. On the other hand, a small C-corporation can provide a dazzling array of tax benefits which can be passed through to employees in the form of tax free fringe benefits which are deductible from corporate income. Within fairly broad limits, a corporation can defer taxes through the use of fiscal year reporting and the accumulation of retained earnings. Let's see if we can conjure up an example.
Suppose a corporation earned about $150,000 per year. It might pay it's Officer/employee $30,000 in wages and salaries. Although this would vary with the age and income of the employee, it could put aside additional money into a corporate pension plan. It could rent a car or truck, its offices, furnishings, equipment, computers, etc. from the employee/owner or his kids separate Trust. That might easily add another $25,000 or so in expenses. It could also pay up to $5250 under an employee educational reimbursement program which would extend to the employee's kids. And it could pay up to $5000 in child care or parental care expenses.
Up to $50,000 in term insurance can be provided tax free to the employee, deductible to the corporation. Or it could pay for a multi-million dollar policy under a split premium plan. The corporation would recover its costs when the policy paid out, or when the employee bought it from the company later on. It can also offer the employee a full range of 'de minimis' benefits which might include the use of a computer, access to wholesale suppliers, free airplane tickets, through frequent flyer trips the employee has earned while on company business. Occasional 'supper money', when the employee has to work late on the job, and medical reimbursement for employees and families, could all be included. Some of these corporate goodies may expire in 1997, but, as usually happens, be reinstated retroactively.
In America today, corporate meetings in exotic locales are the rule rather than the exception. The corporate Officer/employee would naturally be required to attend along with any family members who might be Directors. More money could be siphoned off by hiring family members as full time or temporary employees, during summer vacations. This would transfer pre-tax dollars into lower-taxed hands where it could be used to pay for extras such as cars, vacations, and a college education.
You can see that $100,000 might easily be consumed by the various compensation and employee benefit programs if maximum advantage were taken of the opportunities allowable under the Internal Revenue Code. That would leave $50,000 which would only be taxed in the 15% bracket currently. Up to $250,000 in low-taxed earnings can be accumulated by the corporation. Retained earnings in excess of $250,000 are subject to a special 39.6% surtax unless it can be substantiated that additional funds were needed to fend off a corporate takeover, to prepare for a law suit, to expand facilities, or to pay off debt, etc. Bear in mind that the employee's compensation isn't related at all to corporate profitability.
Employee compensation is usually unrelated to profitability; otherwise, wages might be deemed to be dividends. Sometimes, a small corporation gets locked into a compensation scheme that it can't get out of. So, as profits slump, the corporation borrows from the owner/officer to pay for the costs of operations. Finally, it goes out of business. All the borrowed money that was spent on deductible benefits now represents a loss to the owner. After getting all those tax-free benefits, married owners can now deduct up to $100,000 a year in losses on the value of his corporate stock as an offset to reduce personal income taxes.
To add icing to our financial cake, the corporation also shields the owner's assets from liability and the debts of the corporation. In like manner, the corporate veil insulates corporate assets from the personal financial problems of the owner, especially when the corporation is domiciled in another State.
