What S Corporations and C Corporations should consider

by | Feb 11, 2018 | Blog, Taxes | 0 comments

The battle of supremacy between S & C corporations continues to rage with the new law changes. Even lowering the corporate does not tip the scales in C-corp’s favor, S-corp still stands for savings.

Useful facts about of 2017

There is a myth currently circulating that the Cuts & Jobs Act of 2017 made the plain old corporation (known also as a “C corp”) sexy again. Some people find acid washed jeans fashionable (again?), but that is a matter of opinion. The facts remain that corporations make the most amount of sense with an “S” in front of them. I will leave it to the reader to determine what that “S” actually stands for. The Cuts & Jobs Act certainly lower the corporate to 21%, but that reduction mainly benefits large publicly traded corporations. There still remains only two legal viable ways to get money/and or profits out of a corporation, neither of which avoids double taxation. For this discussion leasing property to the Corporation or lending money to the corporation are not considered viable methods of taking profit out of the Corporation.

Optimizing profit from your C Corporation

The primary way to get funds out of a C corporation is through payroll or compensation, in which the company and the employee split FICA taxes, while the company also shells out for federal and state unemployment taxes. For arguments’ sake, an employee’s compensation costs the company at least 25% more than the gross wages and what the employee takes home varies dramatically. In this scenario the company only pays roughly 25% (payroll taxes) and the employee then pays income on their portion of the wages paid, which is two different types of taxes and not technically double taxation. Common planning techniques usually calculate a bonus to be paid to the Corporation’s owners at year end that would at least avoid the company paying Corporate income , but this does not always work out easily. If the corporation has been making payments against a debt or using cash for similar non deductible purposes, the ability to pay enough payroll to avoid paying corporate taxes often requires a cycle of borrowing that must never end. This scenario is not affected at all with the new rates, for as long as a C corporation seeks to avoid paying any corporate taxes, paying out profits as payroll is the still the default strategy.

Facts about payroll and the C Corporation

If payroll is not your thing and you fancy yourself an investor, then dividends sound like a great idea. Everyone knows that you get special tax breaks for “qualified” dividends, but what does that mean for a smaller C corporation? A dividend is not a magical payment that keeps investors happy, it is a combination of accumulated earnings and – usually – a product of positive cash flow. A corporation cannot pay dividends without positive retained earnings, which ultimately means profits were taxed. In the case of the tax cuts, a $100 profit yields $21 in tax to pay and $79 available for dividends. While that is much better than it was before the rate cut, there are still taxes due on the dividends. At a minimum, another 15% taxes (or $12, rounded) would be due on the dividends*. This brings the total taxes paid on $100 to be ($21+$12=$33) about $33 dollars before considering any other taxes due. This creates a 33% effective minimum federal tax and still leaves off the state’s share of tax. In most scenarios of closely held S-corporations, even after considering payroll taxes, the S-corporation’s overall taxable impact will be lower than the 33% rate a C corporation can achieve.

C Corporation and S Corporation tax review

At your next social gathering as the talk invariably moves to taxes (c’mon you know it’s true) you can perform your very own mythbuster without using your phone. Simply say that the “S” in “S-corporation” stands for sexy and the C stands for “Costly.” If the conversation continues, I recommend getting your phone out and reciting some of the lines from the above paragraph to avoid any shouting. Feel free to recommend that any nay-sayers contact us directly so we can dazzle them with the math!

* In limited circumstances and in the absence of other income, dividends and capital gains can be subject to Zero tax for federal income tax purposes.

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