FINANCE
C Corp Tax Planning Christopher Hynes , JD , CFP ®
Are regular “ C Corportions ” the answer ?
Given the reduced “ flat ” 21 % tax available for C Corporations , many clients with whom I have spoken who cannot take advantage of the QBI deduction have a feeling of wanderlust : would it make sense to “ convert ” their S Corp or partnership (“ Pass-Through Entity ”) to a C Corporation ? Moreover , this option has become ostensibly more attractive now that the “ personal services ” flat tax of 35 %, a longstanding tax plague on the medical profession , has been effectively eliminated by the TCJA . Superficially , it would seem to be mathematically sensible to ‘ swap ’ 37 % money for 21 % money . However , as with most issues that deal with the Internal Revenue Code , the decision is not that simple .
In the context of C corporation tax analysis , one of the first topics that emerges is the fear of “ double taxation .” Because a C corporation is a separate taxpayer , it will file its own tax return and pay taxes at a 21 % flat tax rate on all of its income . After-tax income can then be paid to the shareholder ( frequently also an employee of closely held C Corps .) of the C Corporation as either salary or a “ dividend ”. Income paid as salary is deductible to the C Corporation . So , in essence , it is taxed once . By contrast , income paid as a dividend is not deductible to the C Corporation . It is therefore taxed twice — once on the corporation ’ s return and again on the shareholder ’ s return . As such , the typical federal tax rate calculation on a dividend paid by a C corporation to a shareholder is as follows : 21 % ( Corp Tax ) + 20 % ( dividend tax ) + 3.8 % ( Medicare tax on investment earnings )= 44.8 %.
“ Clearly , the best of times are here for those who understand how to properly structure and integrate a C Corporation into their tax and retirement planning . ”
in salary ? Treas . Reg . § 1.162-8 provides that the income tax liability of the recipient of the purported salary will depend upon the fact and circumstances of each case . If payments “… are found to be a distribution of earnings and profits , the excessive payments will be treated as a dividend .” In other words , the IRS requires that amounts paid to a shareholder-employee of a C corporation for services constitute " reasonable compensation ." If compensation is unreasonably high , the excess amounts may be re-characterized as dividends . This exposes the shareholder-employee to double taxation .
More significantly , for those who are weighing the net difference between a Pass-Through Entity vs . a C Corporation , the idea of taking a salary to avoid double taxation is the proverbial tempest in a teapot . Since the salary will be taxed at “ regular ” income tax rates ( i . e ., 37 %) plus employment taxes , the S-C issue is rendered moot . You end up in essentially the same place as you would be in an S Corp .
The above calculation begs the obvious question : why not simply take all of the compensation of the C Corp
63 TODAY ’ S PRACTICE : CHANGING THE BUSINESS OF MEDICINE