After Tax Reform, Which Is Right for You: S Corp or C Corp?

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.

Rejoice – Business Meals Are Still Deductible

Article Highlights:

• Ban on Deducting Entertainment Expenses
• Business Meals
• Mixed Entertainment and Meals
• Substantiation Requirements
• Disallowed Employee Business Expenses

If you are a business owner who is accustomed to treating clients to sporting events, golf getaways, concerts and the like, you were no doubt saddened by the part of the tax reform that passed last December that did away with the business-related deductions for entertainment, amusement or recreation expenses, beginning in 2018. You can still entertain your clients; you just can’t deduct the costs of doing so as a business expense.

While the ban on deducting business entertainment was quite clear in the revised law, a lingering question among tax experts has been whether the tax reform’s definition of entertainment also applied to business meals, such as when you take a customer or business contact to lunch. Some were saying yes, and others no. Either way, both sides recommended keeping the required receipts and documentation until the issue was clarified.

The IRS recently issued some very business-friendly guidance, pending the release of more detailed regulations. In a notice, the IRS has announced that taxpayers generally may continue to deduct 50 percent of the food and beverage expenses associated with operating their trade or business, including business meals, provided:

1. The expense is an ordinary and necessary expense paid or incurred during the taxable year in carrying out any trade or business;

2. The expense is not lavish or extravagant under the circumstances;

3. The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;

4. The food and beverages are provided to a current or potential business customer, client, consultant or similar business contact; and

5. Food and beverages provided during or at an entertainment activity are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices or receipts.

The IRS notice also included the following interesting examples related to #5: The taxpayer invites a business contact to a baseball game. The tickets to the game are entertainment and not deductible. However, the taxpayer also purchased hot dogs and a beverage for himself and the business contact. Because the food and drinks were purchased separately, they are not disallowed as entertainment and are deductible if they otherwise qualify as an ordinary and necessary business expense. Had the ticket price included the hot dogs and beverages, they would be treated as non-deductible entertainment. If the ticket price separately stated the ticket price and the food and beverage price, then the food and beverage portion would not be disallowed as entertainment.

Of course, the substantiation requirements still apply. You must be able to establish the amount spent, the time and place, the business purpose and the business relationship and names of the individuals involved. You should keep a diary, an account book, digital files or similar records with this information and record the details within a short time of incurring the expenses. If the meal expense is $75 or more, documentary proof (receipts, etc.) is also required.

If you are an employee, starting in tax year 2018, you will not be able to deduct your unreimbursed employee business expenses, including the cost of client meals. These expenses have been deductible as miscellaneous itemized deductions when you itemized deductions and when your total deductions in that category exceeded 2% of your adjusted gross income. Under the tax reform, this category of deductions is not deductible for years 2018 through 2025. So, unfortunately, the IRS’s expansive definition of meal expenses will not benefit you.

If you have questions related to business meals, substantiation or the ban on entertainment expenses, please give this office a call.

IRS Phone Scams - Be Careful of Identity Theft

Over the past several months, the IRS has seen a recent increase in local phone scams across the country, with callers pretending to be from the IRS in hopes of stealing money or identities from victims. These phone scams include many variations, ranging from instances from where callers say the victims owe money or are entitled to a huge refund. Some calls can threaten arrest and threaten a driver’s license revocation. Sometimes these calls are paired with follow-up calls from people saying they are from the local police department or the state motor vehicle department. The Internal Revenue Service does not solicit by telephone, text or email personal information. The IRS generally does business via U.S. Mail . http://www.irs.gov/uac/Tax-Scams-Consumer-Alerts If you get a phone call from someone claiming to be from the IRS, please contact us. If you know you don’t owe taxes or have no reason to think that you owe any taxes (for example, you’ve never received a bill or the caller made some bogus threats as described above), then call and report the incident to the Treasury Inspector General for Tax Administration at 800-366-4484.

Is it true.... Small Filers May Be Exempt - 404 Compliance

House Committee Approves Permanent Exemption from Sarbanes-Oxley Section 404(b) for Small Businesses. The House Financial Services Committee passed H.R. 3817, the Investor Protection Act. The bill includes an amendment, introduced by Representatives Scott Garrett and John Adler, which would permanently exempt small public companies from complying with Section 404(b) of the Sarbanes-Oxley Act of 2002. Section 404(b) requires a registrant to provide an auditor’s attestation report on management’s assessment of internal control over financial reporting. The bill must still be voted on by the entire House of Representatives.

As reported in our Daily News for October 15, 2009, the SEC issued a final rule, Internal Control over Financial Reporting in Exchange Act Periodic Reports of Non-Accelerated Filers, extending the deadline when all non-accelerated filers are required to comply with Section 404(b) to annual reports filed for fiscal years ending on or after June 15, 2010. Presumably, if the Investor Protection Act is signed into law as currently written, non-accelerated filers would be provided permanent relief from the requirements of Section 404(b).

A press release on the approval of the bill discussed above is available at:
http://www.house.gov/apps/list/press/financialsvcs_dem/pressipa_100409.shtml

A press release on the bill discussed above is available from Rep. Adler’s website at:
http://adler.house.gov/index.php?option=com_content&view=article&id=343:house-financial-services-committee-considers-adler-amendment-to-protect-small-businesses&catid=39:2009-press-releases&Itemid=59

Software Revenue Recognition Change

FASB Accounting Standards Update 2009-13 addresses the accounting for multiple-deliverable arrangements to enable vendors to account for products or services (deliverables) separately rather than as a combined unit. Specifically, this guidance amends the criteria in Subtopic 605-25, Revenue Recognition - Multiple-Element Arrangements, for separating consideration in multiple-deliverable arrangements. This guidance establishes a selling price hierarchy for determining the selling price of a deliverable, which is based on: (a) vendor-specific objective evidence; (b) third-party evidence; or (c) estimates. This guidance also eliminates the residual method of allocation and requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. In addition, this guidance significantly expands required disclosures related to a vendor's multiple-deliverable revenue arrangements.

FASB Accounting Standards Update 2009-14 changes the accounting model for revenue arrangements that include both tangible products and software elements. Under this guidance, tangible products containing software components and nonsoftware components that function together to deliver the tangible product's essential functionality are excluded from the software revenue guidance in Subtopic 985-605, Software - Revenue Recognition. In addition, hardware components of a tangible product containing software components are always excluded from the software revenue guidance.

FASB Accounting Standards Updates 2009-13 and 2009-14 are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Early adoption is permitted under both.

These FASB Accounting Standards Updates represent consensuses reached in Issue 08-1 (2009-13) and Issue 09-3 (2009-14) by the EITF at its September 9-10, 2009 meeting.

Sox 404 - Public Companies

SEC Issues Formal Rule Deferring Auditor Attestation of ICFR by Small Public Companies. As reported in our Daily News for October 5, 2009, the Securities and Exchange Commission (SEC) announced that the smallest publicly reporting companies will be required to comply with Section 404 of the Sarbanes-Oxley Act of 2002 requirements related to audits of their assessments of internal control over financial reporting (ICFR). On October 13, 2009, the SEC issued a final rule, Internal Control over Financial Reporting in Exchange Act Periodic Reports of Non-Accelerated Filers. This final rule is consistent with the SEC’s earlier announcement, but clarifies which smaller public companies are covered.

The final rule requires all non-accelerated filers to provide their auditor’s attestation on management’s assessment of ICFR in their annual reports filed for fiscal years ending on or after June 15, 2010. Prior to that time, a non-accelerated filer continues to be required to state in its management report on ICFR that the company’s annual report does not include an auditor attestation report. The scope of the final rule includes all “non-accelerated filers,” which is a term used to refer to a Securities Exchange Act of 1934 reporting company that does not meet the definitions of either an “accelerated filer” or “large accelerated filer” provided in SEC Rule 12b-2.

Reminder about FASB Statement No. 165, Subsequent Events

In May 2009, the Financial Accounting Standards Board issued Statement No. 165, Subsequent Events. CPAs are reminded that Statement No. 165 is effective for interim or annual financial periods ending after June 15, 2009. In many respects, Statement No. 165 does not result in significant changes in subsequent events that an entity reports (either through recognition or disclosure). It does, however, require the entity to disclose the date through which subsequent events have been evaluated, as well as whether that date is the date the financial statements were issued or the date the financial statements were available to be issued. See the Statement.