With the recent changes in the tax code, some small business owners are questioning if their S-corporation tax status is the most tax efficient tax strategy. Close to 30 million business owners have elected an S-corporation tax status resulting in their business profits being included on their personal tax return. This year single individuals earning over $400,000 and joint filers earning over $450,000 will see their incremental top rates increase from 35% to 39.6%. This compares to the top corporate tax rate of 35%. Further, President Obama mentioned lowering the corporate tax rate in his State of the Union address and he previously proposed lowering the rate to 28%.
Many small business owners who take a modest salary from their business may find themselves pushed up into the highest tax brackets when their company’s profit are included with their personal income. According to a Wall Street Journal and VIstage survey, thirty-five percent of the 848 small business owners included in a recent survey said they would consider reorganizing from an S-corporation to a C-corporation if Congress and the President are successful in reducing the top corporate tax rate.
However, though paying a lower tax rate is appealing, there are many other issues to consider before making the move from an S to a C-corporation. C-corporation profits are taxed at the corporate level, and if distributed to shareholders as dividend, taxed a second time on the shareholder’s return. When the company is sold, after the corporation satisfies its tax liability, there is a double tax owed by the shareholder for his profit in the corporation’s stock. Also the IRS requires companies wait five years after switching from an S-corporation to a C-corporation to switch back to an S-corporation. Of course there are various legal and accounting costs associated with changing a firm’s tax status. The bottom line is the optimal tax structure for your business is more than choosing the structure that yields the lowest tax rate on your business’s annual income