Are There Tax Benefits to Switching from an S Corporation to a C Corporation?

 Posted on November 25, 2019 in Taxation Law

A C Corporation is a separate legal entity that protects a business owner’s assets from creditor claims. All corporations are C corporations by default until a business owner files for S corporation status. In a C corporation, business income and expenses are taxed to the corporation. When a business owner or owners receive profits from the business as dividends, the owner(s) must also pay income tax on the profits – creating a double taxation situation. On the other hand, S corporations are “flow-through” entities, meaning business income is treated as owner and investor income for tax purposes. This may make it seem as if operating your business as an S corporation is a better choice than operating it as a C corporation. However, major changes to U.S tax law were established by the 2017 Tax Cuts and Jobs Act (TCJA) that may influence your decision regarding corporation status.

The Qualified Business Income Deduction

The TCJA initiated sweeping changes to tax law, including the new qualified business income deduction, which is also called the Section 199A deduction. This deduction allows certain individuals the opportunity to deduct up to 20 percent of their qualified business income. However, business income generated by a C corporation is not eligible for this deduction. The TCJA also enacted a flat 21 percent tax rate on C corporations, which is much lower than the previous rate of 35 percent. Because income from an S corporation is taxed at the personal level instead of the corporate level, S corporation income does not qualify for the 21 percent tax rate. S corporation income flows through to the shareholders’ personal tax returns and can therefore be taxed at rates as high as 37 percent.

Potential Issues Regarding Switching From S Corporation to C Corporation Status

The Tax Cuts and Jobs Act included provisions to help make the transition from S corporation to C corporation easier. Section 1371(f) extends the time period during which an eligible terminated S corporation can make tax-free distributions from its accumulated adjustments account. Business owners should keep in mind that there is a time constraint regarding the transition relief offered by the TCJA. An eligible terminated S corporation must revoke its S election no more than two years after the TCJA is enacted. This means that reversals after December 22, 2019, will not qualify.

While double taxation still exists for C corporations, it is possible that a C corporation may offer the best option when it comes to minimizing taxes for some business owners. However, there are many situations where business owners will face a higher tax bill if they transition to a C corporation. For example, if your business distributes a high percentage of its profits to shareholders, it is very likely that operating your business as a C corporation will result in a higher combined federal rate than if it were an S corporation. If you want to learn more about which corporation status best suits your needs, speak with an experienced tax attorney.

Contact a San Jose, CA Business Tax Lawyer

If you want to know more about how to realize the tax benefits available under the TCJA, contact John D. Teter Law Offices to speak with our San Jose tax law attorney. Call 408-866-1810 to schedule a consultation.

Sources:

https://www.forbes.com/sites/robertwood/2019/08/29/heres-a-10m-tax-question-c-or-s-corporation/#218545935b99

https://www.irs.gov/newsroom/tax-cuts-and-jobs-act-provision-11011-section-199a-qualified-business-income-deduction-faqs

https://www.investopedia.com/terms/f/flow-through.asp

https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations