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C Corps – Worth Another Look After TCJA
Feb 19, 2020
by Gregory S. Dowell
February 19, 2020
One of the more dramatic provisions of the Tax Cuts and Jobs Act (TCJA) was the reduction of the overall corporate tax rate to 21%. For a quick backdrop, there are effectively two kinds of corporations for federal income tax purposes. All corporations start out as regular run-of-the-mill corporations – let’s call those “C corporations”. A special provision in the Internal Revenue Code allows certain corporations who meet strict criteria to become a “small business corporation”, commonly called the S corporation. C corps who qualify under the criteria can elect to be S corps – thus giving us the two different kinds of corporations, the C corps and S corps.
Because of the benefits of being an S corp, most C corps that could qualify for this status elected to be S corps. Because of a limitation on the number of shareholders, many people assume that S corps are smaller businesses, maybe just a cut above mom-and-pop shops. That is a bad assumption, however. There are some very, very large corporations that have few shareholders and have elected S corp status – so S corps are not necessarily limited to just smaller businesses. Historically, because of the advantages of being an S corp, those businesses that remained C corps were those businesses that had many shareholders (like publicly-traded corporations) and certain other businesses where it was deemed to be strategic to remain a C corp.
Initially, many thought TCJA might dramatically change the landscape for smaller businesses when the highest corporate tax rate was reduced to 21%. While many new C corps were formed as a result of TCJA, in practice we have not seen a mad rush to be a C corp. Largely, that’s because the age-old problem of double-taxation in a C corp still exists, even though it’s less of a problem now with the lower cap of 21%.
Given the interest in C corps, however, it is worth taking a look at some of the basic characteristics of the entity. The following will cover some tax and nontax matters relative to a C corp:
- A C corporation is a corporate entity (either U.S. or non-U.S.). If a U.S. corporation, it is organized at the state level and under state law, not the federal level. A corporation comes into being when its organizers file articles of incorporation with a state (or a country, in the case of a foreign corporation). Ownership of a corporation is in the form of stock, and there is no limit to the number of shareholders that can own a single C corporation. In addition, there is no limit on the number of classes of stock that can be issued.
- Assets and liabilities: A corporation owns its assets and is liable for its debts. Assuming the corporation has been operating as a separate entity and has respected its corporate identity, shareholders are not liable for corporate debt. The fact that the shareholders are not liable for corporation debt is one of the primary advantages of the corporation as a form or doing business.
- Management and employees: The C corporation is managed by its employees, who are hired by the corporation’s board of directors. The members of the board of directors are elected by shareholders. The shareholders do not have a right to directly manage the affairs of the C corporation. Instead, they exercise indirect control over the corporation by electing the board, which then appoints corporate managers.
- Shareholders who provide services to a C corporation are treated either as employees or independent contractors, depending on the specific circumstances, and are taxable on compensation received. When shareholders are employees of a C corporation they are eligible to receive tax-free fringe benefits, such as health care benefits. They can also participate in company-sponsored retirement plans.
- Taxation of a C corporation: A C corporation is taxable on the income it earns. Shareholders of a C corporation are not directly taxable on this income. A C corporation is the only business form where this is the case. All other forms of business are pass-through entities, where owners are taxed directly on entity-level income.
- Although shareholders are not taxed directly on corporation income, they can be indirectly taxable on the income. If a C corporation distributes the income in the form of dividends, then the shareholders pay tax.
- Transfers of assets and liabilities to a C corporation: When a C corporation is formed shareholders contribute cash, property, or services to the corporation in exchange for stock; and sometimes the corporation assumes shareholder liabilities (such as debt to which property is subject). Contributions of property and debt in exchange for stock are usually tax-free; however, there are exceptions. When the corporation assumes debt, and the debt exceeds the basis of property transferred in exchange for stock, then the excess debt triggers gain recognition. In addition, transfers of appreciated property to a corporation in exchange for its stock are tax-free only if the transferors of property own at least 80% of the corporation after the transfer.
- When stock is received in exchange for services provided to a C corporation, the receipt of stock is usually taxable.
- Distributions of property to shareholders: Although the transfer of property to a C corporation is tax-free, the distribution of appreciated property by a corporation to a shareholder is usually taxed. When appreciated property is distributed by a C corporation to a shareholder, either as a dividend or as consideration for the repurchase of stock, the corporation ordinarily recognizes gain as if it sold the property to the shareholder; and, the shareholder recognizes gain equal to the excess of the value of the property received over the shareholder’s stock basis.
- Estate planning: The C corporation is a useful device for minimizing estate and gift tax. In general, stock in a C corporation is often valued (for estate and gift tax purposes) at a discount to the value of assets owned by the corporation.
This is just a brief overview, but provides a look at some of the basic characteristics of a C corporation. When choosing an entity type for a business, it is important to take into consideration as many factors as possible. Even if there is no single perfect choice, careful consideration will narrow down the list and ultimately lead to the best possible entity type.
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by Gregory S. Dowell Updated May 16, 2023 Spring is the traditional kick-off to wedding season, and thoughts quickly turn to the wedding venue, gifts, the happy couple, and, of course, the guest list. Lurking somewhere in the shadows, behind even that strange uncle you barely know, is another guest that needs to be considered: The tax impact on the newlyweds. To start, newlyweds will have two options for filing their income taxes in the year of marriage: Filing status can either be married filing jointly, or married filing separately. In the vast majority of cases, a couple will benefit with a lower overall tax burden to the couple by choosing to file married filing jointly. One of the classic cases where a couple may consider filing separately is when one spouse has significant amounts of medical expenses for the year. Medical expenses are only deductible if they exceed 7.5% of adjusted gross income; using only one spouse's income may allow a deduction to be taken if filing separately, compared to losing the medical deduction entirely if both incomes are combined by filing jointly. We previously had written about the tax trap that often occurs when two people get married, resulting often in an unanticipated balance due when the first joint tax return for the couple was filed. While President Trump’s Tax Cuts and Jobs Act (TCJA), changed the dynamics somewhat, it is still worthwhile to put pen to paper before saying “I do”. Prospective spouses have the opportunity to save money by taking income tax considerations into account before tying the knot. That’s particularly true for those who plan to marry late this year or early next year. As this article explains, from the federal income tax standpoint, some individuals marrying next year may come out ahead by either deferring or accelerating income, depending on their circumstances. Others may find it to their advantage to defer a year-end marriage until next year. For some quick background, a “marriage penalty” exists whenever the tax on a couple’s joint return is more than the combined taxes each spouse would pay if they weren’t married and each filed a single or head of household income tax return. Before President Trump’s TCJA, only the 10% and 15% married filing jointly brackets were set at twice that of the singles bracket, and so the marriage penalty effect on joint filers applied in the brackets above the 15% bracket. Beginning with the 2018 tax year, however, the TCJA set the statutory tax brackets for marrieds filing jointly-through the 32% bracket-at twice the amount of the corresponding tax brackets for singles. As a result, the TCJA eliminated any tax-bracket-generated marriage penalty effect for joint filers where each spouse has roughly the same amount of taxable income-through the 32% bracket. For example, if two individuals who each have $215,950 of taxable income file as single taxpayers for 2022, each would have a tax bill of $49,335.50, for a combined total of $98,671. If they were married, their tax bill as marrieds filing jointly would be $98,671, exactly the same amount as the combined total tax they’d pay as single taxpayers. Because the 35% bracket for marrieds filing jointly isn’t twice the amount of the singles 35% bracket, the marriage penalty effect will still apply to joint filers whose income falls in the 35% bracket. Using 2022 tax tables, two single taxpayers may each have $500,000 in taxable income, for a combined total of $1,000,000, without having any of it taxed higher than 35%. However, for marrieds filing jointly, the 35% tax bracket ends at $647,850 in taxable income, and each additional dollar of taxable income taxed at 37%. Thus, where two high-earning unmarried taxpayers with substantially equal amounts of taxable income are planning for their marriage to take place either late this year or early next, it may pay from the tax viewpoint to defer the marriage until next year. As an example, if two individuals each have $539,900 of taxable income file as single taxpayers for 2023, each would have a tax bill of $162,718, for a combined total of $325,436. If they were married before the end of the year, their tax bill as marrieds filing jointly would be $334,076, or $8,640 more than the combined total tax they’d pay as single taxpayers. If only one of the prospective spouses has substantial income, marriage and the filing of a joint return may save taxes, thus resulting in a marriage bonus. The bonus is the result of two factors: 1) the tax brackets for marrieds filing jointly cover wider spans of income than the tax brackets for taxpayers as singles; and 2) the taxable income of the lower-earning individual may not push the couple’s combined income into a higher tax bracket. In such a case, it will probably be better from the tax standpoint to accelerate the marriage into this year if feasible. There are a number of other factors that should also be taken into account when determining the effect of a marriage on income taxes of the couple. As mentioned early in this post, the first decision is to verify that filing a joint return is preferred to filing separate returns. In addition, many provisions of the tax code phase out completely (or decrease partially) as adjusted gross income increases. In a perfect world, there would only be good surprises for a newlywed couple following their wedding. To avoid any unpleasant income tax surprises, we always recommend that a newlywed couple take the time to make a projection of what their income will look like when combined as a couple, and determine what the tax bill will look like, at the Federal and State levels. After all, planning ahead, communicating with each other, discussing finances, and avoiding unpleasant surprises are some of the keys to a long marriage.
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