C Corps Are Still Likely to be Costlier in an Asset Sale

The 2017 Tax Cuts and Jobs Act established for 2018 a new flat 21% federal income tax rate for C corporations (“C Corps”). This 21% rate is significantly lower than the 2017 top C Corp. rate of 35% and the new 2018 individual tax rate of 37% which would apply to ordinary income from pass-through entities such as partnerships or S corporations (“S Corp”).

So, shouldn’t all companies now opt to be taxed as C Corps? Not so fast. C Corps continue to be taxed at two levels; first at the corporate level of 21% on its earnings and a second time at the shareholder level on dividends at a rate of up to 20% and likely a Net Investment Income Tax (“NIIT”) of 3.8%.

A federal only tax comparison of a C Corp. vs. an S Corp. with net income of $ 1,000,000 might look as follows:

Pretty close but an edge to the pass-through without considering the potential added benefit of the QBI deduction available to certain owners of pass-through entities such as S Corps and Partnerships, but not C Corps. State income taxes were also not factored in order to simplify these examples.

Using the same comparison, assume the net income is $5,000,000 resulting from the gain from selling its business in an asset sale.

The vast majority of sales of closely held businesses take place as asset sales and give rise to capital gains when intangible assets such as business goodwill, customer lists, etc. are either all or a substantial part of the assets sold. The pass-through entities allow the capital gains to be subject to the capital gains tax at a maximum rate of 20% and, if assuming the owner was active in the business sold, the gain is also not subject to the NIIT.

In conclusion, the C Corp. is likely still the less desirable entity type for most closely held businesses, especially if you feel you one day might sell your business. 

Do you have questions about whether the C Corp. is the right entity type for your business? Consult an adviser at BSA or a tax adviser to review the entity tax status of your business.

This is How the New Tax Laws Affect Small Businesses

A recap of the major changes impacting corporations and
closely held firms

Do you know how the Tax Cuts and Jobs Act of 2017 changed the tax picture for business owners like yourself? Whether your company is incorporated or closely held, you must recognize how the recent adjustments to the Internal Revenue Code can potentially affect you and your employees. 
 
How Have Things Changed for C Corps? 
The top corporate tax rate has fallen. C corps now pay a flat 21% tax. For most C corps, this is a big win. For the smallest C corps, however, it may be a loss. How so, you ask? (1)
 
If your C corp or LLC brings in $50,000 or less in 2018, you will receive no tax relief. Your firm will pay a 21% corporate income tax as opposed to the 15% corporate income tax it would have paid in 2017. Under the old law, the corporate income tax rate was just 15% for the first $50,000 of taxable income. (1),(2)
 
For those who do business outside of the U.S., note the change impacting C corps and taxation of repatriated income. Prior to 2018, American companies paid U.S. tax rates on earnings generated in foreign countries. Companies were essentially taxed twice on those profits. Under the new law, they are taxed differently. There is a one-time repatriation rate of 15.5% on cash (and cash equivalents) and 8% rate on illiquid assets, and those taxes are payable over an 8-year period. (2)
 
Also, say goodbye to the 20% corporate Alternative Minimum Tax (AMT). The tax reforms permanently abolished it. (2)
 
What Changed for S Corps, LLCs, Partnerships, and Sole Proprietorships? 
These companies can now deduct 20% of the qualified business income they earn in a year. Cooperatives, trusts, and estates can do the same. This deduction applies through at least 2025. (2),(3)
 
Pay attention to the fine print on this deduction. If you are a lawyer, a physician, a consultant, or someone whose firm corresponds to the definition of a specified service business, then the deduction may be phased out, depending on your taxable income. Currently, the phase-out begins above $157,500 for single filers and above $315,000 for joint filers. Above these two thresholds, the deduction for a business other than a specified service business is limited to half of the total wages paid or one quarter of the total wages paid plus 2.5% of the cost for that property, whichever is greater. (2)
 
Don’t worry too much about your salaried workers joining the ranks of independent contractors to exploit this deduction. They may find it a wash since they will have to pay for their own health insurance and absorb an employer's share of Social Security and Medicare taxes. (2)
 
What Other Major Changes Occurred? 
The business depreciation allowance has doubled and so has the Section 179 expensing limit. During 2018-2022, the percentage for first-year “bonus depreciation” deductions is set at 100% with a 5-year limit. It applies to both used and new equipment. The maximum Section 179 deduction allowance is now $1 million (limited to the amount of income from business activity) and the phase-out threshold is now $2.5 million, $500,000 higher than under previous law. Also, a business can now carry forward net operating losses indefinitely, but they can only offset up to 80% of income. (4)
 
The first-year depreciation allowance for a car bought and used in a business role is now $10,000. It was $3,160. If you claim first-year bonus depreciation, the limit is $18,000. (Of course, the depreciation allowance for the vehicle is proportionate to the percentage of business use.) The Tax Credit and Jobs Act also created a new employer tax credit for paid family and medical leave in 2018-19, which can range from 12.5%-25%, depending on the amount paid during the leave. (4),(5)
 
Some longtime business tax deductions are now absent. Manufacturers can no longer claim the Section 199 deduction for qualified domestic property activities. Business deductions for rail and bus passes, parking benefits, and commuter vehicles are gone. The Act also repealed deductions for entertainment costs linked directly to or associated with the conduct of business. (4)
 
Business owners should also know about the new restriction on 1031 exchanges. A like-kind exchange can now only be used for real estate, not personal property. (3)

The Tax Cuts and Jobs Act brought a lot of changes to taxes for small business. We can help you understand how those changes impact your business. Contact us today. 

This material was prepared by BSA using information provided by MarketingPro, Inc., and does not necessarily represent the views of BSA.  This information has been derived from sources believed to be accurate. The publisher is not engaged in rendering legal, accounting, or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax, or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. 

Citations:
(1) - thebalancesmb.com/corporate-tax-rates-and-tax-calculation-397647 [2/5/18] 
(2) - investopedia.com/taxes/how-gop-tax-bill-affects-you/ [2/14/18] 
(3) - americanagriculturist.com/farm-policy/10-agricultural-improvements-new-tax-reform-bill [12/27/17] 
(4) - cpapracticeadvisor.com/news/12388887/2018-tax-reform-law-has-benefits-for-some-small-businesses [1/2/18] 
(5) - marketwatch.com/story/use-your-car-for-your-small-business-the-new-tax-law-is-good-news-for-you-2018-03-06 [3/6/18] 

Why Focus on Maximizing Enterprise Value?

As a business owner, your company may just be your most valuable asset. So why aren’t you doing more to maximize your enterprise value? 

Consider this hypothetical business owner whose net worth is approximately $12.21 million. Without factoring in the value of his/her business, the owner is worth nearly $3.71 million when you take into account the owner’s personal real estate holdings, retirement plans, residences, and other non-business-related assets. 

If you’ve quickly done the math, you’ve discovered that the net worth of the business makes up 70 percent of the owner’s net worth, assuming they can monetize it. 70 percent! 

When your business makes up the majority of your net worth, its value will greatly impact your personal and financial goals. You want to work on an exit or succession plan with a trusted adviser who will look at the operational areas of the business that present opportunities to improve overall quality and increase value. That way, when an opportunity for succession or a sale arises, you’ll benefit from the work put in to maximize enterprise value.