When the taxing landscape changes, it follows that business owners will examine their corporate entity format to be sure they remain properly positioned. For instance, if the owner’s personal rate exceeds corporate, some S corps may convert to C corps. The American Taxpayer Relief Act of 2012 (ATRA), changed the horizon just enough to warrant a reassessment, but in the years following, most companies have failed to take a good hard look at whether they should remain S corps.
Conventional wisdom prior to 2012 steered many owners toward S-corp structure. As pass-through tax entities, the profits or losses of S corps are reported on the owners’ personal tax returns, and paid at the historically-advantageous individual level. Also, shareholders incur payroll taxes only on their wage compensation, not on S corp profits.
C corps pay taxes at the corporate level. But owners then face a second layer of taxation if corporate income is distributed to them as dividends, which are taxed on their personal return. More importantly, the same double taxation threat looms in some instances of sale or liquidation.
After ATRA, some owners began paying a significantly higher individual rate than their business’ potential corporate rate. So have the scales tipped? Could restructuring your S corp as a C corp now be the smarter approach?
Your answer should be determined by taking a holistic look at your unique tax attributes, as well as your business’s likely future.
- Do you have a large number of non-deductible expenses?
- How are you impacted by the tax attributes that currently flow through your entity to you as an individual, such as depreciation and expensing allowances?
- Are you paying additional Alternative Minimum Tax (AMT) that would be alleviated if your corporate profits no longer hit your personal return?
- Would you see clear advantage from the fringe benefits available only to C corp owners?
- Are you more likely to sell your business or transfer it to the next generation?
The last question may be the most difficult, but the most important. If you face eventual liquidity, you and your advisor will likely decide to position yourself for that long-term event, rather than your situation in the short-term. In that case, it’s possible that a C corp structure would be tax advantageous today, but detrimental tomorrow.
Should you consider changing your entity structure? A CSH advisor can help you explore the possibility.
Further resources for examining the right entity structure for your business: