united-states corporate-law tax-law
Setting up two corporations to split profits and reduce tax brackets
<p>Let's say I am receiving income in a corp from multiple entities for consulting services and most of the money I make I keep in my company to potentially pay out dividends in future years.</p>

<p>Would it make sense to split the income (and therefore the profits) between multiple corporations to keep in the lowest corporate tax brackets?</p>

<p>Let's say I have a yearly profit of $120,000. If the current tax brackets for corps are as follows: </p>

<pre><code>   Taxable income over     Not over      Tax rate

      $         0        $    50,000        15%
           50,000             75,000        25%
           75,000            100,000        34%
          100,000            335,000        39%
          335,000         10,000,000        34%
       10,000,000         15,000,000        35%
       15,000,000         18,333,333        38%
       18,333,333         ..........        35%
</code></pre>

<p>It seems I should set up 3 corporations, have my clients pay each of them about $40,000, and thus each corporation would only get taxed 15%. Thereby saving $12,000-$23,000 in taxes.</p>

<p>I could easily imagine creating <em>N</em> number of corps and spreading profits between them all to have the lowest tax rate.</p>

<p>This all seems pretty easy and obvious to me, yet I don't see any advice on the subject anywhere on the internet. </p>

<p>Is this legal? </p>

<p>Am I missing something fundamental? Because otherwise, it seems like a pretty huge tax loophole that I would imagine would be heavily abused.</p>

<p>I have extensive domain knowledge of your question.</p>
<p>In short, your plan won't work. Here's why...</p>
<hr>
<h3>Corporate Taxation and the double taxation problem</h3>
<p>Corporations are taxed in the U.S. as separate legal entities (unless they meet certain exceptions described below). Therefore, if your corporation does not avoid being taxed as a separate legal entity, your plan will fail due to the “double taxation” problem. I.e, Your corporation will be taxed first at the corporate level. Then after you pay the corporate tax, YOU WILL BE TAXED AGAIN as an individual, when you take the money out of the corporation via income or dividends. Or if you decide to leave the money in the corporation, there is an excess retained earnings penalty.</p>
<hr>
<h3>Subchapter-S election and "flow-through" entities</h3>
<p>The way to avoid the double taxation problem is to make a &quot;Subchapter-S election” for your corporation. This &quot;S-election&quot; will cause the corporation to be treated as a “flow through” entity for taxation purposes — allowing the owners to be taxed at the individual level only. The IRS imposes additional limitations and restrictions on these &quot;S-corporations&quot; and their ownership structures. Limiting things like the number of owners the corporation can have etc. The problem is that even with this subchapter S election, your concept still won’t work. This is because ALL your income will &quot;flow through” all your corporations (via IRS Form K-1) and accrue to you at the individual level. Therefore, nullifying the “compartmentalization of income” effect you were trying to achieve.</p>
<hr>
<h3>Conclusion</h3>
<p>In short, your plan won’t work. There are too many rules in place to effectively close the loophole you imagined might be.</p>
<blockquote>
<p><strong>Disclaimer:</strong> I am not a lawyer or an accountant. This answer is not legal or accounting advice. Please consult the proper professionals for appropriate professional advice.</p>
</blockquote>

<p>Generally speaking, this is handled by the rules on "<a href="http://www.irs.gov/pub/irs-tege/epchd704.pdf" rel="nofollow">controlled groups</a>." See Revenue Code §1563(a) for "mechanical ownership tests, which are used in determining if a controlled group situation exists." </p>
