February 20, 2021

SPEED ROUND: Entity Selection: S Corporations

Dark Horse CPA

Learn what you need to know about C Corporations (and why investors prefer them) before you decide on which entity type is best for your business. Join Dark Horse CPA, Erik Hegstad, as he takes you through the quick & dirty on C Corps.

Podcast Transcript

hello and welcome. You're tuned into Texas made simple for a speed round on C corporations. My name is chase Berkey, CEO of dark horse CPAs. And I'm joined again by Mr. Eric , who is our resident entity selection guru. This episode, we'll round out our speed round series on entity selection. And yes, there are other types of entities out there, but LLCs as corpse and C corpse are by far the most popular entity types, the others are largely variations of partnerships or other entities with pass through taxation, which we covered on the LLC podcast.

So moving on, Eric, thank you again for carving out time for this discussion. Absolutely. Thanks for having me back. I'm excited to discuss the world of C Corp. A lot of people wonder why they would want to pick a C corporation as their entity of choice when they know about the whole double taxation thing.

So can you tell us a little bit about what that means? Sure thing, double taxation means that the corporation has to pay tax on its profits. And when those profits are distributed to shareholders, usually in the form of a dividend, the shareholder then has to pay the tax for those dividends on their personal tax return.

So those profits are taxed twice once at the entity level. And one's at the shareholder level, well said. So tell me why entrepreneurs should be considering a C corporation in spite of this double taxation. So there are a couple of reasons. One is that C corporations can qualify to have their shares treated as qualified small business stock.

When shares are treated this way, capital gains can be entirely tax-free. You got to love that. And the company does need to be a C corporation when the shares are issued. So you'd be wise to educate yourself on the onset. So as to avoid a headache down the road. So what else do our listeners need to consider to make sure that they're making the right entity decision here?

Well, they need to make sure their business objectives align with the C Corp structure. If they're going to need to take on a lot of investment capital and we'll be running losses for years while they are building the company, a C Corp is a great choice. Since the double taxation would be a moot point without taxable income at the entity level.

Also investors typically prefer a C Corp structure. Is there much fewer limitations on who and how many shareholders there can be as well as the fact that. See course allow for the most after-tax capital to be reinvested in the business. Let me stop you there. What do you mean by that? When a company is a pass through entity, they have to pay tax at the

individual level, which is often taxed at rates higher than the corporate tax rate, which is currently 21%.

The shareholders are going to pull money out of the company to pay their tax bills. Thus with a C Corp more after tax money, it can be left in the company if the shareholders choose not to distribute it. Yep. And one thing to keep an eye on is that the corporate tax rate is almost certain to increase from the 21%.

You mentioned earlier under president Biden. The consensus is currently that it will move to 28%. But one other thing I'd like to point out is that C corporations dramatically simplify investor's tax situation since they don't receive a K one. Yeah, absolutely. Everyone's lives become a little bit easier when there's no pass through income because there's just some inherent complications.

There also investors prefer corporations due to the well established legal framework that governs them as compared to LLCs. So are there situations where the double tax structure of a C Corp can actually be beneficial in terms of the total tax paid? Yeah. Mostly be if the company is able to get the right balance of tax rate and tax year arbitrage, what I mean by that, for example, when current corporate tax rates are 21% and your individual tax rate could be North of 40%, you could be in a much better position to have your income tax at 21% and distribute the income in the form of dividends in later years where you could.

Take it out as rates as low as 0%, even in a situation where the total tax between the 21% and the tax on the dividend are the same as your current personal tax rate, you still achieve significant tax deferral. So there's a lot of moving parts there, not the least of which is a fluid regulatory landscape, but it should be known that double tax does not always mean

more tax.

So what about this whole idea of a fiscal year? Yeah. A fiscal year is basically a tax year that doesn't line up with a calendar year ending on December 31st. And the idea being that the owner has some leeway and when they pay their salaries to make sure to choose the best balance of income tax on the personal and corporate level.

For example, if the court had a fiscal year, end of March 31st, they could backload salary into January through March so that the court could take the deduction that year. And the owner wouldn't have to recognize the income until the following year. Okay. So we've been talking up the positives of C Corp's here, but what are some of the drawbacks.

There's obviously the double taxation that we mentioned, which can hurt, hurt you when you're trying to distribute profits to shareholders. When earned, especially if the corporate tax rate jumps also Biden has been talking about having dividends, taxed as ordinary income for those at certain income levels, which would make double taxation hurt a lot more.

There's also the corporate formalities that you need to be aware of and handle that you don't with an LLC. You, we made it. Eric very informative as always to our listeners. If you have questions on entity formation, or if you just need a new CPA and you like what you're hearing from Eric, you can email him at Eric at dark horse dot CPA.

And once again, that's Eric with a K at dark horse dot CPA. So as always, we'd like to thank you for tuning into TMS, or if you're not into the whole brevity thing, taxes made simple because there's TMI and then there's TMS.

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