Should My Business be a C-Corp

One of the most reported and discussed changes (and the one that is “permanent”) within the Tax Cuts and Jobs Act of 2017 is that of the drastically reduced corporate tax rate. So consequently, we are fielding many questions regarding the prospect of changing from an S-Corp or LLC to that of “C” Corp.

Quick question, but not a quick answer. We look at a host of factors to include:

What does the company do? i.e. an active operation, hold real-estate, etc.

A multi-year analysis of historical and potential earnings and net income;

The owners’ timeline for exiting their business and what (if any) that strategy is;

Ownerships personal tax situation;

The company’s history and potential capacity for paying distributions, dividends or draws to ownership; and

Financial metrics such as:

Interest expense to income

Debt to sales and Debt to assets

Debt service to operating (and/or) taxable income

Now, under the new rule for 2018 and forward, if you own a C corporation, you will see a flat tax of 21%. This is great for C corporations that have large amounts of net (taxable) income. However, and of note, the first $50,000 of C-Corp earnings had been taxed at 15% and then next $25,000 at 25% previously – so for small C-Corps that control their corporate profit through wages and other expenditures to ownership there is not much (if any) benefit here.

This rate drop from 35% to 21% is related to C-Corps only.

In my opinion there are now five reasons to be a C-Corp:

1. You are planning to seek outside investment or even “go public”;

For Real Estate ventures this can generally be done effectively in an “LLC”

2. When the passive activity loss rules and the at-risk rules severely limit the shareholder’s (or member’s, or partner’s) ability to deduct corporate losses;

3. When the corporation wants to accumulate income to be used in the future;

4. If the ability to limit self-employment taxes is eroded (i.e. you are paying yourself a high wage (say $150k+) to drive high amounts into a pension plan (say $50k+)); and

5. If your debt and equity structure requires a high level of cash flow related to the repayment of debt and therefore distribution/dividend/draw capacity is limited. Since debt has to be paid back with after tax dollars (profit) (or new debt…but I digress) the lower rate may be attractive depending upon ownerships personal tax picture.

So, if this is type of thing that is important to you, be sure to connect with your professional advisors because the time line for many of these changes to be effective for 2018 is March 15th