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The Farm CPA

RSS By: Paul Neiffer, Top Producer

Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.

Take Advantage of Tax Rate Arbitrage!

Mar 02, 2011

Many farmers created a corporation several years ago to operate their farm.  Many of these corporations have been converted over the years into S corporations.  However, one of the potential drawbacks is the retained earnings inside of the corporation that need to be distributed at some point in time.

Normally, S corporation basis is fixed at December 31 each year.  If the corporation has a large loss, the shareholders may not be able to deduct the loss on their personal tax return.  However, if the S corporation has retained earnings from its regular corporation period, the shareholders can elect to "distribute" this as a dividend and the technically recontribute the distribution back to the corporation as additional paid in capital.
The tax arbitrage feature of this strategy is that the dividend is taxed at a maximum rate of 15% (for federal purposes) and the ordinary loss that will flow through to the shareholders will be deductible at their marginal tax rate which could be as high as 35%.  For example, if the corporation distributes a dividend of $200,000, the tax would be $30,000, and if the taxpayer is in the highest rate, the loss that flows through would save $70,000 of taxes or a total of $40,000 in net tax savings.
If this applies to you, make sure to discuss with your tax advisor.  Certain elections need to be made on the S corporation tax return and all shareholders must agree.
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