The JGTRRAs Tax Rate Cuts: A Financial Incentive For Tax Planning By Owner/Executives Of Small To Medium Closely Held C-Corporations

Abstract

The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), creates a financial incentive for the owner/executives of small to medium size closely held corporations to deviate from the Pre-JGTRRA 2002 historical allocations of average taxable corporate income before owner/executive compensation to taxable salary and qualifying dividends.  For purposes of comparison, this paper summarizes the 2002 tax year average taxable corporate incomes before owner/executive compensation for small to medium size closely held corporations, the 2002 average allocations to taxable salary and bonuses or qualifying dividend income and the tax consequences of those allocations.  The 2002 tax year average allocations and tax consequences calculated using the JGTRRA’s tax bases and rate parameters are compared with the results of an iterative numerical search procedure that incorporates the JGTRRA’s tax base and tax rate parameters to mathematically estimate tax-minimizing allocations to owner/executive salary and bonuses versus dividends.  Comparisons of the estimated tax-minimizing allocations’ 2004 (JGTTRA) tax consequences with the 2002 (using JGTTRA) tax year’s average historical allocations’ tax consequences indicate that the JGTRRA has created a financial incentive to deviate from the historical allocations to salary and bonuses versus dividends of the taxable corporate income before owner/executive compensation.  One caveat or constraint to adjusting historical allocations to tax-minimizing allocations would be that the Internal Revenue Service might challenge adjusted allocations as unreasonably low salary compensation that would deprive the treasury of Social Security and Medicare taxes.  Another constraint is that the iterative computations are ceteris paribus for those factors not included in the computational formula.  Specifically this paper does not model for tax deferred contributions to retirement plans and does not model for the impact of the American Jobs Creation Act of 2004 and the deduction for qualified U.S. production activities.