This post was originally published on July 17, 2013, and updated on September 27, 2018.
With the recent change in the Tax Cut and Jobs Act, new business owners are asking what is the best entity set up, and current business owners are asking if they should move their C corporation switching to an S corporation. The answer really depends on what the long-term goals are for the business.
What are your long-term goals for the business?
The right structure doesn’t just depend on the state of your business today; it also depends on where you would like to be in three to five years, or even longer.
If you’re looking for fast growth, which takes cash, C corporations allow for multiple classes of stock and don’t restrict the number or type of shareholders. They’re the best fit if you’re seeking investments from venture capitalists, or if you plan on becoming a publicly traded company, rather than a privately owned one, in the near- or mid-term.
Another consideration is what happens when you or another owner dies, goes bankrupt or withdraws. Corporations live on after these events, but generally, the other types of business structure dissolve unless specified otherwise beforehand.
What are the basic benefits of a switch?
If a C corporation owner elects S corporation status, the corporation’s income and deduction items are passed through to the owner, reported on his or her 1040 and taxed at personal rates. Significantly, switching to S status would avoid any threat of double taxation on (1) future corporate operating profits and (2) future appreciation in corporate assets that occurs after the switch.
As you may know, double taxation occurs when a C corporation pays corporate-level tax on its income and gains. The owner then pays taxes again at the shareholder level when those income and gains are distributed as taxable dividends.
In contrast, a business owner is only taxed once under the S corporation form of doing business, while retaining other benefits such as corporate protection from personal liability.
What are the drawbacks to a switch?
The decision to switch isn’t always a slam-dunk. If the owner has substantial income from other sources or if the company is quite profitable. He or she may be forced to pay the 35% maximum rate on most or all of the incremental income passed through. Rule of thumb: with the current tax brackets in effect, the owner often fares better if the company generates annual profits of less than $100,000.
In addition, beware of the onerous “built-in gains” (BIG) tax. It comes into play if the corporation owns appreciated assets when it switches from C to S status. When this corporate-level tax applies, the rate is 35%.
If you have more questions about which entity is right for you than call our office. You can speak to one of our Tax Professional and have all your questions answered with no obligation. The number is 800-878-4051 or you can click on the link to schedule an appointment online right here.
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