CONTINUED
TO C, OR NOT TO C?
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Four Questions To Consider
Are you profitable?
Since tax is paid on profit, if you have little or no profit to pay tax
on, the potential savings a change in entity could generate would
probably not outweigh the time, effort and cost to actually make
the change. The more profit there is to tax, the more potential there
is for a reduction in tax paid.
2
Is your balance sheet ‘above water?’
If your balance sheet is “above water,” it’s reflecting more assets
than liabilities. If it’s “under water,” it’s showing more liabilities than
assets. When considering a change of entity, your balance sheet
should be above water. Depending on your business’s existing en-
tity type, conducting a change of entity with an underwater bal-
ance sheet could trigger a taxable event, going against your goal
to minimize your tax burden.
3
Does a substantial amount of profit generated
by your business stay in your business?
Historically, C corps weren’t a preferred entity of choice for small
businesses because of the double taxation on profits distributed
to the owner. What may be forgotten, however, is that the second
layer of tax isn’t actually imposed until the profit is distributed from
your business to you (the owner) as dividends. If the profit never
leaves the business, the second layer of tax is never incurred.
There are a number of reasons you may choose not to distribute
profits to yourself, but two of the most common are high rates of
capital reinvestment into the business and the repayment of debt.
Both of which are usually undertaken to support growth within the
business. If this sounds like your scenario, the new lower tax rate
at the corporate level may generate substantial tax savings on the
amount of profit being used for these purposes.
On the flipside, if your tendency is to distribute large portions of
business-generated profit, switching to a C corp may not be for
you. Any distribution of profit as a C corp dividend would be sub-
ject to that second layer of tax at the individual level, possibly elim-
inating any benefit generated by the lower corporate rate.
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Do you plan to retain long-term ownership
of your company?
If you’re planning to sell your business in the next few years, it’s
better to operate as a pass-through entity rather than a C corp, es-
pecially when company assets are involved. This isn’t as critical if
the transaction is structured as a sale of corporate stock, but such
a transaction usually isn’t as lucrative when compared to purchas-
ing a company’s assets, which would include goodwill.
Once you’ve transitioned, you must retain C corp status for at least
five years. Additionally, the IRS imposes an additional five-year
waiting period to avoid a business-level tax on the sale of assets
if a change is made back to a pass-through entity from a C corp.
This means that if you were to sell your business’s assets during
the 10 years after you elect to become a C corp (at a minimum),
you would be taxed on all of the gains. This includes any deprecia-
tion recapture, at the business level first and then again when the
proceeds are distributed from the company to you as a dividend.
Being subjected to two layers of tax would be much less advanta-
geous when compared to the single layer of tax you would pay on
the same transaction if your business was a pass-through entity
the entire time.
These questions are just the tip of the iceberg. If you need help
determining your business’s best course of action, contact Rea &
Associates for more information.
STILL WONDERING IF CHANGING YOUR BUSINESS ENTITY IS A GOOD MOVE?
Listen to episode 119: “tax cuts and jobs act: implications for c corps & flow-through entities,”
on unsuitable on Rea Radio to hear Chris Axene break down this portion of the TCJA.
www.reacpa.com/episode-119
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