Corporations Should Consider Paying Dividends in 2012 Before Tax Rates Go Up!
We want to alert corporate business owners to tax planning opportunities that exist this year that will allow them to tap into the hard-earned cash of their business at historically low tax costs.
Normally, dividend treatment is something to avoid because of the double taxation issue. In effect, dividends are subject to double taxation. A corporation pays income taxes on the earnings that generate the dividends, then it has to pay income taxes too when the earnings are paid out to the shareholders. This harsh effect has been softened somewhat for the last several years because the maximum dividend tax rate was only 15%. However, in 2013, barring any tax legislation, this favorable maximum rate is scheduled to skyrocket. The actual tax rate you will pay on dividends will depend on your marginal ordinary tax rate. However, for taxpayers in the top ordinary tax rate bracket, it looks like the federal tax rate could be as high as 43.4% after 2012.
If your corporation has built up substantial earnings and profits over the years, sometime before the end of 2012 is an ideal time to consider paying some dividends. Although, double taxation is assured, a 15% tax rate may be quite manageable. In addition to getting cash into your hands at historically low tax rates, paying dividends this year may have additional benefits for your corporation:
- Establish a Dividend Paying Record. A history of paying dividends will make it more difficult for the IRS to characterize compensation paid to business owners (which is deducible by the corporation) as disguised dividends (which aren’t deductible). In other words, future compensation amounts will be easier to defend as reasonable if at least some dividends have been paid in the past
- Better Tax Treatment for Distributions in Future Years. To the extent 2012 cash distributions reduce the corporation’s earnings and profits, there’s a greater likelihood that distributions in future years will be treated as tax-free returns of capital or as long-term capital gains (which may once again be taxed at lower rates than dividends).
- Reduce Future Exposure to Accumulated Earnings Penalty Tax. A profitable corporation becomes exposed to the accumulated earnings penalty tax when it accumulates earnings in excess of reasonable business needs and does not pay dividends. Right now, the accumulated earnings tax rate is only 15%. Absent a law change, after 2012, the accumulated earnings tax rate will return to the maximum individual federal rate on ordinary income—39.6% for 2013. Therefore, now is a great time to pay out dividends and reduce your corporation’s exposure to this penalty tax.
As you can see, the current low federal tax rates on dividends make the idea of taking corporate distributions a better idea than at any time in recent memory. With careful planning, we can help you determine whether you would benefit from having your corporation make dividend distributions this year.
Clients inquiring about assurance or audit services, often assume that their organization requires a financial statement audit. This assumption is made without fully understanding all the available assurance services that a CPA can provide. A CPA may compile, review or audit an organization’s financial statements.
The level of service is often determined by the client’s needs and what their creditors, investors, funding sources or government agencies require. The higher the level of service required, the more time the CPA needs to complete the engagement and therefore the more costly the engagement. Complied statements will usually be sufficient for management use, owners who are not active in management probably prefer reviewed statements and banks and other creditors usually want an audit.
Compiled financial statements represent the most basic level of service a CPA may provide with respect to financial statements. In a compilation engagement, the CPA assists management in presenting financial information in the form of financial statements without undertaking to obtain or provide any assurance that there are no material modifications that should be made to the financial statements.
The CPA issues a reporting stating the compilation was performed in accordance with Statements on Standards for Accounting and Review Services; and that the CPA has not audited or reviewed the financial statements and accordingly does not express an opinion or provide any assurance about whether the financial statements are in accordance with the applicable financial reporting framework.
Reviewed financial statements provide the user with comfort that, based on the CPA’s review, the CPA is not aware of any material modifications that should be made to the financial statements for the statements to be in conformity with the applicable financial reporting framework. In a review, the CPA designs and performs analytical procedures, inquires and other procedures, as appropriate, based on the accountant’s understanding of the industry, knowledge of the client, and awareness of the risk that he or she may knowingly fail to modify the accountant’s review report on financial statements that are materially misstated. A review does not contemplate obtaining an understanding of the organization’s internal control; assessing fraud risk; testing accounting records; or other procedures ordinarily performed in an audit.
The CPA issues a report stating the review was performed in accordance with Statements on Standard for Accounting and Review Services; that management is responsible for the preparation and fair presentation of the financial statements in accordance with the applicable financial reporting framework and for designing, implementing and maintain internal control relevant to the preparation and fair presentation of the financial statements; that review includes primarily applying analytical procedures to management’s financial data and making inquiries of management; that a review is substantially less in scope than an audit that the CPA is not aware of any material modifications that should be made to the financial statements for them to be in conformity with the applicable financial reporting framework.
Audited financial statements provide the user with the CPA’s opinion that the financial statements are presented fairly, in all material respects, in conformity with the applicable financial reporting framework.
In an audit, the CPA is required by auditing standards generally accepted in the United States of America (GAAS) to obtain an understanding of the organization’s internal control and assess fraud risk. The CPA is required to corroborate the amounts and disclosures included in the financial statements by obtaining audit evidence through inquiry, physical inspection, observation, third-party confirmations, examination, analytical procedures and other procedures.
The CPA issues a report that states the audit was conducted in accordance with GAAS, the financial statements are the responsibility of management, provides an opinion that the financial statements present fairly in all material respects the financial position of the company and the results of operations that are in conformity with the applicable financial reporting framework (or issues a qualified opinion if the financial statements are not in conformity with the applicable financial reporting framework. The CPA may also issue a disclaimer of opinion, if appropriate).
Another type of engagement that clients often find useful and less costly is an agreed upon procedures engagement. An agreed upon procedures engagement is generally an engagement that involves applying procedures that have been agreed upon by specified parties (for example the client and a government agency). A report that details the procedures performed, and states the CPA’s findings. Such an engagement is useful for an organization that has no need for financial statement assurance, but would like a CPA to evaluate certain matters significant to the organization.
As you can see, management and third parties relying on the financial statements of an organization can obtain a varying degree of assurance depending on the service they request from their CPA. How much assurance does your organization need? Contact us to discuss.