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Most closely held/family businesses are S corporations. Good! Almost all profitable small businesses should be an S corporation (pays no tax), as opposed to a tax-paying C corporation. Yet over the years at my many tax-planning seminars, one of my standard lines was, “Every small business owner is entitled to one good dog and one good C corporation.” I meant it then, and still mean it now.

The line always got a chuckle from the audience followed by some questions.

Okay, here’s the corporate setup we usually recommend to profitable family businesses: Your operating company should be an S corporation (Success Co.) (although an LLC is acceptable). A new C corporation (Newco) should be created.

Here’s why: Newco would be a regular or “C” corporation for federal income tax purposes. Its business purpose would be to provide sales, marketing and administrative services to Success Co. On a regular basis, Newco will receive payment for its services. The compensation that Success Co. pays is deductible by it and is income to Newco. Among the tax benefits that Newco could provide the owner and other selected employees are the following:

1. Qualified retirement plan benefits. Newco would adopt a qualified retirement plan — typically a 401(k) plan or a profit-sharing plan — that allows significant contributions for the benefit of its few employees (usually the owner of Success Co. and their family members).

2. Health care insurance. Newco can pay for and deduct (a) 100 percent of the health insurance premiums and (2) any uninsured medical or dental expenses that the employees (their spouses and dependents) incur. There benefits are tax-free to the employees.

3. Entertainment expenses. Newco, as a C corporation, is taxed at the rate of 15 percent on the first $50,000 of taxable income. Under the current tax laws only 50 percent of entertainment expenses can be deducted. The remaining 50 percent is essentially paid out of after-tax dollars. Assume that Success Co. is in the highest tax bracket (35 percent). When these nondeductible expenses are paid by Newco, they are paid with 85 percent after-tax dollars rather than 65 percent (Success Co.) after-tax dollars.

4. Long-term care. Newco could buy long-term care insurance for each of its employees (and their spouses); deduct 100 percent of the cost, while the employees receive the entire benefit tax free. A great — little known — tax trick.

A small summary. The big deal is that none of the benefits offered by Newco to its hand-picked employees are required (under the tax law) to be offered to any of the other employees of Success Co. Simply put, you have found an easy way to avoid those blasted discrimination rules that apply to Success Co. (And all closely held businesses).

Here’s a benefit (a huge tax saver) that only applies to some owners. If your Success Co. does business in more than one state, this Newco strategy can easily be set up to incur income tax only in the state with the lowest tax rate. If you (the owner) winter in a no-income tax state, like Florida, then this little gem of a strategy easily eliminates all of the income tax on your salary from Success Co.

And one final point: Regular readers of this column know that the prime subject matter of this column is estate planning, business valuation and succession, retirement, insurance, significant charitable gifts and related areas. What most business owners don’t know is that the way to beat up the IRS — legally — is to have two plans make up your estate plan: (1) the traditional will and trust (really a death plan) and (2) a lifetime plan (when done properly, the IRS is out of the estate tax game — totally eliminating the tax — when you go to heaven).

The “Newco Strategy” outlined above is just one of the many strategies we use when doing the lifetime portion of your estate plan. Of course, the lifetime plan dovetails with your estate plan.

The nice part of the Newco Strategy is that it is easy to start, maintain and is very flexible (add or eliminate employees to Newco.).

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Irv Blackman is a certified public accountant and lawyer who specializes in estate planning, business succession and asset protection. Contact him at Blackman@EstateTaxSecrets.com or call 417-9732. His Web site is www.taxsecretsofthewealthy.com.