Should You Change Your Corporate Tax Structure? The Answer Requires Close Examination

November 13, 2019

The conventional wisdom used to be that S corporations were—in some cases—superior  to C corporations because of their tax structure. Rather than paying the hefty corporate tax rate plus individual taxes (on salary and dividends) required of C corporations, S corporation shareholders are only taxed once. Profits (or losses) “pass through” the corporation and land on their individual returns.

The Tax Cuts and Jobs Act of 2017 muddied the waters when it reduced the corporate tax rate to 21 percent. This was good news for C corps, of course. But individual rates dropped, too, meaning that S corp shareholders would also be paying less.

These modifications of the tax code have some companies wondering whether they should consider changing their tax structure to try to minimize their IRS obligations. Our response to that? One is not inherently superior to the other. What’s best for your company is dependent on a variety of factors.

Many Similarities

To determine which structure would be more beneficial to your business, it’s important to understand the differences between the two types of corporations. We’ll start, though, with the attributes they share. All corporations start their lives as C corps; you have to file for S corp status with the IRS after you’ve incorporated and all shareholders have approved the change (and all guidelines are met).

Both types of corporations:

  • Must file formation documents with their states.
  • Have directors (high-level decision-makers), officers (day-to-day operations managers), and shareholders (owners).
  • Offer limited liability protection (shareholders not personally responsible for the company’s liabilities and debts).
  • Share standard corporate responsibilities (bylaws, meetings, reports, etc.).
  • Continue to exist after their owners’ deaths.

Distinct Differences

The taxation variations we already described comprise the most significant difference between C corps and S corps. There are others, and their importance to you is dependent in part on your short- and long-term goals for your company. For example, do you plan to grow significantly or do you already have a great number of employees? S corps aren’t allowed to have more than 100 shareholders, all of whom must be citizens or residents of the United States.

If you’re a large business that has plans for an IPO down the road, C corps offer more flexibility. They’re not limited to specific business types like S corps are. Banks, some insurance companies, and other entities cannot form S corps.

Further, S corps are limited to only one kind of stock, which gives everyone equal voting rights. C corps can have many.  On the other hand, if you’re a fairly new company that is still operating at a loss, you can write off those losses on your personal tax returns, which will offset other income if you’re an S corp. An S corp may also be more tax-advantageous if you’re preparing to sell a business because of the difference in how taxable gains are handled.

Every Situation Unique

You can see why we’re unable to recommend a particular tax structure without knowing a lot about your company and its goals – especially given the changes in the tax code that occurred last year. We’re always available to sit down with you and analyze your business to see if a different type of entity would better match your needs. Contact us, and we’ll schedule a consultation.

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