Tax shelter ideas for contracting position -looking for input

PrincipalMember said: I have not done a contracting position so please pardon my ignorance.

Is there a way to structure a contract with a company so that I can do contracting work for 4-5 years and then have them make payments over the next 10 years after the 4-5 years are up? Even if this was possible, how would one mitigate the risk of the company going belly up? Until you actually get the cash, there's always the risk of the company going bankrupt - see (I think) Nolan Ryan and the bankrupt Texas Rangers.

And I'm thinking you might have issues convincing a company to structure your pay like that anyways - most dont want lingering payments a decade after the work is done.

And you are right in that having them pay a corp generates taxable income for the corp for that year. Paying yourself a salary will offset the income, but not until many years in the future (from what you say, probably too late to carryback the loss to offset past income).

Just take you cash now, save it, and start drawing on it 5 years. Its better to have the cash sitting in your account than some company's account. The earnings from letting it sit around for 5 years should come close to making up any extra tax costs of being paid now.

You can try any of the above but the IRS will shut it down...This is what is called a structuring and goes from being tax planning to tax avoidance which is a no-no! The C-Corp will cost a fortune..the reporting requirements alone will cost alot, the record keeping and filing alone ...it's alot (I'm an accountant...)The taxationon a C-Corp is a whole different story, you can't add to retained earnings until after you pay taxes, yes there are states that are tax free for corporations...there are still federal taxes 15% for <50K to 39% for 100k to 335K ...so a C corp isn't cheap. IF you want to design a way to divy up your earnings my advise is to go and talk to a CFP. You might be able to create a profit sharing plan with an S Corp...but you should talk to a professional the fees to set it up may not be worth the savings.
One more idea is to call your brokerage company (I generally recommend Fidelity or Vanguard) and see if they can help with the nuts and bolts of setting up a plan...you may want to start there since the services they offer are often free!

PrincipalMember said: Is there a way to structure a contract with a company so that I can do contracting work for 4-5 years and then have them make payments over the next 10 years after the 4-5 years are up? Even if this was possible, how would one mitigate the risk of the company going belly up? [Thinking here is that if I can do this, then I can potentially retire in 4-5 years since I will be stretching the income stream for 10ish years and by doing that, reduce the top tax rate - i.e. instead of the money going to IRS, it is my retirement income stream. I have other income in the next 4-5 years - so receiving contracting payments earlier still would keep me in high tax bracket].

Alternatively, is it possible to setup some kind of a small corp or something that receives the funds from the contract and then pays me salary as and when I desire over the next 10-15 years? I am thinking that this method would mitigate the risk of the company going belly up and potentially achieve similar thing. However, if this small corp has to pay taxes, then this may lead to double taxation.

[Note: I am aware of the SEP IRA which allows you to defer 49K per year but I am thinking of larger deferral amounts].Except in a qualified plan, anything that makes the money "yours" -- no longer subject to employer credit risk -- means that you have "received" the payment, no matter what account it's in; if you're on the cash method (as virtually all individuals are), that means it's taxable at that time. (If you switch to the accrual method, the income is generally taxable when you do the work it relates to, no matter when paid, which won't help you here.) If you have it paid to a C corporation, then it's taxable to the C corporation; that means an eventual double tax, and not much money at even temporarily lower rates.

It used to be easy to get almost what you want with a "rabbi trust": the employer (or person who would be paying the independent contractor) would set up a trust they would pay; the trust was subject to claims of the employer's creditors, but the employer wasn't allowed to touch it otherwise. But Congress enacted sec. 409A to impose a big penalty on people who do that, or anything else that results in deferring income outside of a qualified plan. There are a lot of exceptions, and very complicated rules; you can read up on 409A, but need to work with a professional if you want to do something that squeezes into those exceptions.

But note that anything that delays your tax on the income usually delays the employer's deduction for its payment to you. That is no problem where the employer is tax-exempt (like the synagogue that set up the original rabbi trust for its rabbi); otherwise, it means the benefit to you is offset by the cost to the employer, unless it doesn't care about taxes for some other reason (like, if it's a startup that expects to have losses for the foreseeable future).

You can use a SEP, or a qualified plan, but that has the same limits. A defined benefit plan potentially lets you defer a huge amount of income, but it's a major hassle; it's doubtful the tax savings would justify the cost if it's only going to last 5 years.

All things considered, I don't think you are going to find an attractive alternative to just deferring the most you can in a SEP or defined-contribution plan (like a 401(k)), and paying attention to taxes in general, being careful to deduct everything you're entitled to.

It's funny that I'm going to make this recommendation but I would set up an s Corp and start a 401k profit sharing with a 412i made up of annuities. It will do what u r asking

PrincipalMember said: But the bottom line seems to be that I might be able to setup a s-corp which could then setup some kind of retirement plan for me. So I will pay taxes on what I am not able to defer as part of the defined contribution plan but I will take a look at the limits to see if it is good enough for my purpose (since we all have to pay taxes - only question is how much).There are some reasons you might want an S corporation, but you will be able to defer just as much without one.

Yoksel said: BradMajors said: If you work only for one company for 4 or 5 years then the IRS will say you are an employee and not a contractor regardless of the how you "structure your contract".

I believe that only applies if you are a direct contractor to that company.
Simply creating a corporation and acting like an employee changes nothing, you are an employee.

BradMajors said:
Simply creating a corporation and acting like an employee changes nothing, you are an employee.

OK - so what happens if I create this company and I hire my dog as an additional employee? [I don't have a dog now, but that can be fixed! ]

My point being that I could create a small corporation whose job is to provide some kind of consulting services. Today, it may be just me doing the work - but that is the start of the business. During the course of the year, I could hire an intern or something and lo and behold, I have more than 1 employee company! So who is the employee now - is it me or is it my intern or both? Since I can fire the intern, how is the employee of the organization that I am consulting for?

PrincipalMember said: BradMajors said:
Simply creating a corporation and acting like an employee changes nothing, you are an employee.

OK - so what happens if I create this company and I hire my dog as an additional employee? [I don't have a dog now, but that can be fixed! ]

My point being that I could create a small corporation whose job is to provide some kind of consulting services. Today, it may be just me doing the work - but that is the start of the business. During the course of the year, I could hire an intern or something and lo and behold, I have more than 1 employee company! So who is the employee now - is it me or is it my intern or both? Since I can fire the intern, how is the employee of the organization that I am consulting for?
That's exactly my point.
Actually you can hire your wife (if you have one but that can be fixed ). That will work much better for your benefits such as an individual 401(k).

there are tons of people who work as contractors and thus set up their own company to do so. Heck the government itself (military, VA) hires a truck load of people that way on a long term basis. Likely the only way the IRS would care is if your intent was to do this purposefully in order to create a tax shelter of some kind but they would have to prove that you did it intentionally. when u sign on as a contractor, you sort of know that u can be let go easily and that u can work for other companies at the same time if desired. if the job happens to be longer than initially planned then no big deal.

Yoksel said: winter said: I have (1099) contracted to the same company for 5 years and the IRS has not said I am an employee therefore your statement is demonstrably false.That's not a reasonbale statement. If someone cheated on his taxes for 10 years and the IRS didn't catch him, it doesn't mean that you should do the same.First, the post I responded to (which you omitted) said "if you do X then Y will happen". It did not say "if you do X then Y may happen".

Second, your analogy doesn't hold. I cannot force the company I work for to treat me like an employee instead of a 1099 contractor - that is their choice so if anyone is going to be held responsible it is them, not me. So I didn't "cheat". In terms of "catching" me - you make it sounds like this is done through deception/secrets: since all of these records are electronic it would be trivial for the IRS to "catch me" just by running a DB query for these conditions...funny that they have not.

I know many people that have worked as contractors for the same company for periods much longer than 5 years and I am not aware of any adverse IRS action either against those contractors or the companies they work for.

PrincipalMember said: LH2004 said: There are some reasons you might want an S corporation, but you will be able to defer just as much without one.
You were mostly right but see below. Basically, most of the retirement plans that you can setup limit you to $49K per year and you definitely don't need to establish an s-corp to get that level of deduction.
It may not matter in your situation but even if the level of deduction is the same ($49K) coming to that level is different depending on whether you have a corporation or not. With the corporation you can set up an individual 401(k) plan and qualify $16.5K as employee contribution. If you don't have a corporation, your contribution will be limited to 20% of your self-employed income so essentially you need higher income level to arrive to $49K.
On the negative side, as far as I know the $49K limit was a part of Bush tax cuts and nobody is clear on what the next year's situation will be.

The IRS very much cares about whether you are properly classified as an employee or an indepedent contractor. The IRS has a twenty question "test" to determine if you can be classified as an indepedent contractor. There are significant taxes and penalties for violations. They have significantly increased audits this year of companies claiming independent contractors.

The states are even more aggressive. They want workman's compensation taxes as well as unemployment taxes. Whereas the IRS is somewhat subjective and will classify you as and independent contractor if you are on the right side of 12-15 out the twenty questions (as long as a few key ones are right). My state requires 100% correct answers to their twelve questions.

There are low six figures of "companies" representing high six figures of workers "each year" found to be in non compliance. The companies and the individuals are assessed backed taxes and penalties. So like any other tax avoidance, just because you have gotten away with it doesn't mean an audit of you or the company you worked for won't cost you.

Larger companies have compliance units to vet their hiring of independent contrctors. So, the IRS/States are increasingly targeting smaller businesses for employee/independent contractor audits.

Yoksel said: btuttle, thank you for the explanation but I still don't really see why the IRS cares. The amount of federal taxes doesn't really change anyways. Payroll tax is also the same, just the burden is moved. As far as the states, the state tax should stay the same as well. The only difference is in the unemployment tax but if the contractor works through his/her own company and pays himself/herself a salary, that tax will also be paid. So what's the difference?You are now asking the eternal question, why does the IRS care. Or more importantly, why does congress pass the laws directing the IRS to care. Yes the payroll taxes is paid regardless who does it.

It is probably a means to effect public policy. After all isn't that what our tax code has become. They don't want companies treating employees as contractors to deny them benefits. So they assess penalties to enforce it.

Unemployment tax and workmans comp. If you don't pay into it, you don't get to collect. So there again it is a means to have more people covered by these programs.

Independent contractor status works for higher paid professionals who understand they are on their own. However, some companies would prefer to have most of their employees as independent contractors and probably pay them the same hourly rate.

dhodson said: id still consider 412i if u are thinking of retiring after 5 years of work bc it will allow u to put closer to 200k away tax deferred. prb is your choice of investments is just insurance products (annuities and life insurance). id consider just annuities if i were u and wanting to retire in 5 years.

Good tip giving me the plan # (412i). My search led to this example:

412 plan example

PrincipalMember said: OK - finally had a chance to read the tax document that I had linked in earlier.

LH2004 said: There are some reasons you might want an S corporation, but you will be able to defer just as much without one.You were mostly right but see below. Basically, most of the retirement plans that you can setup limit you to $49K per year and you definitely don't need to establish an s-corp to get that level of deduction. The only interesting twist might be is that if you have an S-corp, you can hire your wife too and pay her an equally high salary (if the funds allow). So now, you are up to $98K deduction. If IRS comes around asking what was your wife doing for the $200K in salary, that might be a tough one to defend if she is not actually doing really useful work while on payroll.No, that is not a difference at all.

If you set up a corporation, then the corporation can pay salaries to you and your wife, and then a portion of those salaries can be contributed to a retirement plan. If you don't set up a corporation, then you can pay a salary to your wife, and she can contribute a portion of her salary, and you can contribute a portion of your net self-employment income, to a retirement plan.

Again, there are some marginal differences that might lead you to want an S corporation, such as an ability to avoid some self-employment income, but the basics, including the amount you can contribute to a retirement plan, will be exactly the same, assuming you pay out all net income as salaries. You could choose to pay even more, if you funded that yourself, but that isn't typically something people want to do (for one thing, because it means there will be more payroll tax to pay).

LH2004 said: If you don't set up a corporation, then you can pay a salary to your wife, and she can contribute a portion of her salary, and you can contribute a portion of your net self-employment income, to a retirement plan.

Not sure how that works. So as an example, even though I am salaried now, are you saying that I can hire my wife without having a corporation? If yes, then does it lead to double taxation - once on my salary and then her salary? Is the difference that as a contractor, i can deduct her salary as an expense?