Deferred Compensation Plan

Date 07/10/99 Primary Author: D Scott Beane, CPA

Question: C corporation contains appreciated real estate, how gain be sheltered sale from double taxation?

Answer: Rule 101, never place appreciated property in a C corporation. S corporations and partnerships (LLC) avoid double taxation upon sale. Electing S corporation status requires a 10-year waiting period to avoid the built-in gains tax and greater than two percent owners loose the tax benefits of fringes, which, if there are a large number of shareholders might be quite material.

I suggest looking at a deferred compensation plan, also referred to as a "top hat" plan. In general, such plans increase the owner-employee compensation but rather than a current pay out, an amount is deferred to a future date and deducted when paid. The liability can also accrue interest. Over time, such plans can accumulate to significant sums. For example, deferring 50k per year at a 9% interest rate for 10 year amounts to almost $760,000! The key is to pay it out the same year the appreciated real estate gain is realized, thus lowering the over all C corporation taxable gain. The corporate level tax savings in this example, assuming 34% federal and 7% state income tax rate would be $293,512.

It is important to understand that such plans:
1. must be written and registered with the DOL (one time),
2. annually the deferral is subject to FICA and Medicare tax,
3. however, at receipt there is no FICA or Medicare tax, a good retirement planning idea which will not effect SS benefits,
4. it is important not to annually exceed reasonable compensation to owner employees, such excesses could be reclassified as dividend payments,
5. such a liability will also accrue for financial statement purposes, though you should have a deferred tax liability asset to offset it a bit. I've found that such liabilities require some education of bankers and vendors. Debt subordination is frequently requested.

Yes, we have top hat planning documents and DOL filing compliance letters ready to go..



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