How the New Tax Law Affects C Corporations

The Tax Cuts and Jobs Act (TCJA) made significant changes to the federal tax law, including a significant decrease in the corporate tax rate.

Beginning in 2018, the tax rate for c-corporations is a flat rate of 21%. This is great for existing corporations, as they were previously taxed at rates up to 38%.

But what if your business is not currently classified as a c-corporation? Does it make sense to switch entity types to take advantage of the new, lower rate? The answer is it depends. Every business is different, and their tax situation should be analyzed carefully before making a decision on an entity change.

However, it is important to note some factors that should go into this decision. One is that c-corporations are still subject to double taxation. This means that the corporation pays income tax at the entity level. Then, if the owners take the profit out of the company, they are then taxed on that distribution as dividend income or compensation. Thus, the profit of the company has now been taxed twice.

In addition, one of the other changes in the TCJA is a new 20% deduction on pass-through business income. If your business is classified as a pass-through (including sole proprietorship, partnerships, and s-corporations), you may be eligible for this deduction which would lower the tax on your business income.

There are other tax and accounting changes that may be required to change to a c-corporation, so it is very important to consult your tax advisor regarding this decision.

If you have any additional questions, please contact Rebecca Bischoff, CPA at 314-576-1350 or rbischoff@bwtpcpa.com.

Built-In Gains Tax

Many medium and small companies who operate as corporations choose to be taxed as an S-Corporation. Operating this way eliminates the double taxation (income tax imposed on both net taxable corporate income and subsequent distributions made to shareholders) that corporations would otherwise have. Income taxation at the corporate level can still occur, however. One way this can occur is the built-in gains tax. This is normally incurred when the fair market value of the assets of a corporation exceed their adjusted basis at the S-election effective date, and the newly formed S-Corporation subsequently disposes of any of these assets during a five-year window after the S-election is effective. When a built-in gains tax is triggered, it is taxed at the highest corporate tax rate, which is currently set at 35%.

There are several ways to reduce or entirely mitigate the imposition of this tax:

-Do not dispose of the assets for five years after the S-election effective date.
-Demonstrate that the assets were acquired after the S-election date.
-Utilize Net Operating Losses (NOL) carried forward from the time the Corporation was still taxed as a C-Corporation to offset the recognized gain.
-Demonstrate that the assets appreciated in value after the date the S-election was effective.
-Dispose of assets with built-in losses during the same periods as a disposition of assets with built-in gains to offset taxable income.

 

If you have any questions, contact Tony Mueller, CPA at 314-576-1350 or tmueller@bwtpcpa.com.