Tax law prompts rethinking of common wisdom
The 2017 Tax Cuts and Jobs Act (TCJA) has called into question the traditional value proposition for S corporation status for many closely held companies. Indeed, many owners of such companies have been making the switch to C corporation status, and many more are thinking about doing so.
S corp status has long been attractive to many small companies due to their being taxed only at the shareholder level, instead of both the corporate and shareholder levels. However, new tax rates under the TCJA are impacting the "S or C corp" calculation.
New Tax Math
The top C corp federal tax rate prior to 2018 was 34% and now stands at 21%. Indeed, the tax math can add up in favor of C corp status for some business owners today when it didn't before.
One business category whose owners might be strong candidates for converting from S to C corp status includes those falling under the "specified service trade or business" (SSTB) heading of the 2017 tax law. SSTBs are pass-through businesses like Sub S corps involved in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, among other categories.
Another category of potential converts from S to C corp status is highly profitable businesses. In general, that's because high profits attributed to S corp owners push them into higher tax brackets, with higher proportions of their income taxed at higher rates. Owners of C corps have the flexibility (within certain parameters) to allow profits taxed at today's 21% corporate rate to accumulate within the corporation and be set aside for future needs.
Pros and Cons
Other potential C corp status advantages include:
- Greater flexibility in the timing of taking profits and losses for tax purposes, such as raising or lowering executive compensation
- Minimizing taxation on the value of employee benefits such as health insurance
- The ability to have multiple stock share classes, such as preferred in addition to common
- Being better positioned to attract investment capital from outsiders (For example, S corps are limited to 100 shareholders.)
Even so, C corps can have drawbacks compared to S corps. For example, maintaining C corps sometimes involves higher total legal and accounting expenses than maintaining S corps.
Making Your Evaluation
Switching from S corp to C corp status triggers a variety of accounting and tax issues that must be addressed. In addition, the timing of revoking S corp status needs to be carefully considered in light of tax implications both for the company's primary shareholders and the corporation itself.
Switching from an S to a C—and then back to an S corp (known as a rescission) within a relatively short space of time could cause you to incur extra accounting and legal expenses that exceed your tax savings from the original switch to C status. It is therefore essential to consider the matter carefully and comprehensively.
Tax and specialized life insurance professionals can help you evaluate all your options.
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The information provided should not be considered as tax or legal advice. Please consult with your tax advisor and/or attorney regarding your individual circumstances.
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