C or S Corporation Dilemma Under the Tax Reform
When you first see that 21% tax rate for the C corporation, do you think that this could be the choice of entity for your business operation?
Further, when you find yourself in the out-of- favor group for the 20% deduction, don’t you naturally gravitate to thinking about the C corporation, perhaps as a means of getting even.
Let’s look at the following example: Say that you are in the 34% tax bracket, and let’s say that you have $100,000 in profits.
If you operate as an S corporation, the profits come to you on a K-1 and you pay your Form 1040 taxes at the 34% rate, for a total tax on your S corporation profits of $34,000. If you operate as a C corporation, the profits are first taxed at the C corporation level at a rate of 21%, for a tax of $21,000. This leaves you with $79,000 of the $100,000 in profits available for distribution as a dividend to you.
You are in your “give me the money” mode, so to get the cash, you endure the double taxation, starting with the dividend tax of 15%. This creates an $11,850 tax ($79,000 x 15%).
Your tax bracket also triggers the net investment income tax (NIIT) that applies because of your dividend income. The NIIT is $3,002 ($79,000 x 3.8%).
As a C corporation, your total federal taxes on the $100,000 of income are $35,852, which consist of the following:
- C corporation taxes of $21,000
- 1040 dividend taxes of $11,850
- 1040 NIIT of $3,002
Based on the same $100,000 in profits, operating as an S corporation results in $34,000 to the government compared with the C corporation, which pays $35,853. The winner: the S corporation.
This analysis does not even take into consideration the 20% deduction that can benefit the S corporation, but not the C corporation. This means that if you qualify for the new Section 199A 20% deduction, continuing to operate as an S corporation is more to your benefit than we just concluded.
How about if my net profit is lower or higher than $100,000? How about wages paid by the corporation, don’t they place some sort of a ceiling at how much I’d pay in taxes? How does my medical insurance expense come into play? Does a retirement plan contribution have any bearing? How does other sources of income impact this analysis?
To answer all these questions, you need to run a more precise analysis considering various factors in addition to the net profit factor. You don’t want to jeopardize your 20% Section 199A deduction either.
If you are interested in a tax planning session for your business and would like to determine whether a switch to a C corporation makes sense under the new rules, I have already started scheduling tax planning sessions beginning in May. Please get in touch with me if you would like to gauge your potential tax savings or expense and advice on how to best structure your business.