Cash is King

By September 30, 2014 Businesses

The 2014 income tax filing season is almost in the books.  The corporate extension deadline has passed and the individual extension deadline is nearly here.  Of course, this means it’s time to start doing tax planning for this year.  As usual, there are some tax changes to be aware of as well as new strategies to help you maximize tax savings.  There are also some changes on how things can be done.  A recent tax court decision calls for caution when using some tax planning tools.  A ruling against Vanney Associates (Vanney Associates, TC Memo. 2014-184) shows that for the IRS cash is king.

In the Vanney Associates case, a sole shareholder wrote himself a payroll check and then endorsed the check back over to his company because there were not actual funds in the business account to pay that payroll check.  The tax court denied the company’s $815,000 deduction because the check was not cashable when the owner received it (Kiplinger, 2014).

Shareholders write themselves year-end checks for a variety of reasons.  In some cases, year-end tax planning reveals that a shareholder may need to withhold more taxes than they have throughout the year.  In the case of some retirement plans, such as SEP plans, contributions are limited to 25% of compensation.  There are some other tax advantages involved with year-end bonus checks.  The tax court ruling may eliminate the ability to write that year-end check if cash is not available.

This doesn’t eliminate year-end bonuses for cash strapped companies, however it may put a timing burden on shareholders.  Shareholders may satisfy the tax court’s requirements by contributing their own funds into the company as a loan from shareholder and then paying themselves through payroll.  However, this case shows that cash must change hands. Unfortunately, this creates other pitfalls to be aware of with shareholder loan balances, documentation, and minimum interest rates.

Year-end tax planning is a great way to save a company cash and prevent April 15th surprises.  On the other hand, tax planning done poorly can be costly.  An $815,000 disallowed deduction multiplied by the corporate tax rate (plus interest and penalties) is not a pretty sight.