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Should you switch to a C corporation?

December 5, 2013

A recent change in tax rates may cause S corporations to think twice about their entity structure.

For the first time in a decade, the top tax rate for individuals is greater than that of corporations. As it stands, the top corporate tax rate is 34% for companies with less than $10 million in taxable income. The current top tax rate for individuals is 39.6%.

This means that S corporations, in which business profits (taxed at the highest individual rate) and tax burdens are “passed through” to owners, are now taxed at a higher rate than C corporations. The new 3.8% Medicare tax, along with the potential tax effect of deduction and exemption phase-outs, could push owners of S corporations to an effective tax rate of 45% or higher.

For this reason, owners of S corporations should take a close look at their entity structure to make sure it’s still the best option.

Planning to sell your company or pass it to the next generation?

At face value, a C corporation appears to be the obvious choice for tax savings. However, there are several important issues to consider before making the leap from S to C, one of which is the sale of assets.

S corporations offer significant benefits when it comes to the sale of assets. For C corporations, the sale of assets is subject to “double taxation.” Generally speaking, this means proceeds from the sale of assets will be taxed once at the corporate level (at corporate rates), and again when distributed to shareholders (at capital gains rates).

When S corporations sell assets, owners are able to take advantage of lower capital gain rates, as well as tax-efficient techniques for gifting and estate planning.

Know the ABCs of S or C

In addition to a lower tax rate, switching to a C corporation could provide other tax and operational benefits. But your company and your situation are unique; make sure your entity structure is a good fit across all aspects of your business. And it’s important to note: While switching to a C corporation is not a permanent choice, you must wait five years before reverting back.

You tax professional can help you determine if switching to a C corporation is advantageous for you—and your company’s long-term goals.

Andrew Thom, CPA, CPE, is AEM’s Manufacturing Segment Leader. When he’s not navigating southern Minnesota waterways in his kayak, he’s helping clients navigate changes in their business. You can reach Andy at 507.304.6830 or at andrew.thom@aemcpas.com.

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