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After Tax Reform, Which Is Right for You: S Corp or C Corp?
The Tax Cuts and Jobs Act has left many of today’s businesses with big questions. Incorporation remains a hot topic, but this law is shaking things up. It’s quick to assume your company should be one or the other, but without careful consideration of the facts, your organization may end up facing financial loss, hefty tax penalties or missed tax savings.
The goal of this type of incorporation is to minimize tax burdens, but the wrong decision can be costly. In a C Corp, the company pays corporate taxes to the Internal Revenue Service. But, in an S Corp, there’s no entity tax. Rather, taxes are paid through an individual return.
The New Law Changes
The new law, which went into effect for the 2018 tax year, brought changes to both S Corp and C Corp businesses. In fact, both types of corporations benefited here. For C Corps, the tax rate was dropped from 35 percent down to just 21 percent. For an S Corp the new law provides a deduction equal to 20% of the pass-through income from the corp subject to limitations for higher-income taxpayers. At best, this reduces the effective tax rate to 29.6 percent from 37 percent. In both cases, there are specific restrictions here to know.
One thing to remember about these tax changes is that there are many components to determining which method is right for your business. Don’t make a quick judgment here. Rather, invest in some one-on-one time with your tax professional to determine the best possible scenario for your individual company. To help, consider these key areas.
S Corp and C Corp Ownership
A key component in deciding how to incorporate your business relates to ownership. In the S Corp, there is a limit of 100 shareholders within the company. These must be domestic organizations operated in the United States where all of the company’s shareholders are also living in the United States. Additionally, this structure allows for a single stock classification. As a business, you cannot offer common stocks as well as preferred shares, for example.
Comparatively, C Corps allow for fewer restrictions. There is no limit on ownership at all. There is no limit on the number of shareholders the company can have. Any small- to a medium-sized company planning an IPO or simply obtain investors outside of the traditional domestic structure will find C Corps offer far more flexibility.
Another key factor about C Corps relates to the differences within your shareholders. These corporations can issue several types of stock. As a result, it is not uncommon for some shareholder votes to be more important than others. This, too, can influence the decision you make in choosing one or the other model.
Corporation Taxation – Choosing the Best Taxation Structure
Most companies will focus most of their decision on S Corp or C Corp options based on ownership as a starting point. However, every company also wants to keep costs low. Taxation is one of the most expensive hurdles any organization must manage. And, each type of structure offers a different look.
For example, consider how a C Corp is taxed. It is commonly referred to as a “double taxation structure.” This is because the company (the entity itself) will pay a corporate tax. Then, the stockholders pay taxes on their income from the business. While this has long been a concern for any business owner using the C Corp structure (paying taxes twice on income is very costly), the new tax law changes this a bit. As noted previously, the tax rate for C Corp has changed from 35 percent to just 21 percent. However, the dividends will still be faced with double taxation.
The slashing to 21 percent means every company is paying the same rate, neither the size of the company nor the type of organization matters. That’s an important consideration when choosing which type of structure is right for your company.
With the help of a tax professional, it is also important to consider other tax strategies available. For example, an S Corp shareholder pays taxes every year on the money the company earns during that year. This is a simpler, straightforward scenario. But, in a C Corp, the taxes are only paid when the company decides to distribute dividends. It can also occur if a shareholder realizes capital gains (such as when selling ownership). This provides the C Corp with an ability to minimize taxes just by timing dividends properly.
Making the Right Decision for Your Needs
This is only the very top edge of considerations for which is best for your company. However, there are a few things that can influence your decision.
Stable Small Businesses
If you own a smaller company, you’ll benefit from an S Corporation for various reasons. First, the income passes through and is taxable to the stockholders on their 1040s, thereby eliminating double taxation. Plus the lower tax rate and the 20% pass-through deduction are very beneficial to an S-Corporation structure.
Growing Small Businesses
If your company is growing – or you plan to go public and take on new ownership, the C Corporation offers the opportunity to do so. It allows for a larger number of investors, and international investments are possible. Additionally, as a smaller business, you may not be likely to issue dividends any time soon. As a result, this can reduce the amount of income reported to the IRS on an annual basis.
Larger Companies
For larger organizations, the C Corp tends to offer the best structure overall. Other options limit investor access and may create scenarios where the company cannot grow. The effective tax rate is significantly lower – competitive to any company no matter the size. The new tax reform provides the most advantages to this buyer in particular.
Making the Decision for Your Needs
Many organizations today have jumped on the new tax reform as an opportunity to incorporate more tax savings. However, a clear picture is important. It’s important to slow down before making any type of drastic decisions like this. They have far-reaching implications and can create a financial burden or limitations on an organization if the wrong decision occurs. However, with the help of a tax professional or attorney, it is possible to make better decisions based specifically on the type of business structure you have, the business’s short-term and long-term goals, as well as new laws and taxation rates. Before you make a change as an entrepreneur, know what you are really getting.
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Offices in Flemington, NJ and Califon, NJ
Our Mission: At Prestige Accounting Services Group (previously Prestige Wealth Accounting Group), we are on a mission to redefine the tax experience for individuals and small businesses. With a focus on personalized service, strategic planning, and expert guidance, we aim to empower our clients to succeed financially with confidence and ease.
Expertise in Action: With a wealth of experience and a team of dedicated professionals, we specialize in individual and small business tax preparation. While we excel in all areas of taxation, our passion lies in serving the unique needs of small business owners in New Jersey. We understand that small business taxation requires specialized knowledge and attention to detail, which is why we go above and beyond to ensure our clients receive the guidance and support they deserve.
Tailored Solutions for Every Client: Whether you're a high-net-worth individual seeking comprehensive tax planning or a small business owner in need of accounting and bookkeeping assistance, we have the expertise to meet your needs. Our team takes the time to understand your specific situation and develop customized solutions that align with your goals and objectives.
Why Choose Us?: What sets us apart from other New Jersey tax firms is our commitment to excellence and innovation in the field of taxation. We don't just prepare tax returns; we provide strategic insights, proactive planning, and actionable advice to help our clients achieve their financial goals. With a team of two CPAs, an EA, and an ERO, we have the expertise and resources to deliver exceptional service and results.
Your Success is Our Priority: At Prestige Accounting Services Group (previously Prestige Wealth Accounting Group), we measure our success by the success of our clients. We are dedicated to building long-lasting relationships, providing unparalleled service, and helping our clients thrive in today's ever-changing tax landscape.
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