No one will argue with this little piggybank – money plus money is more money. In fact, that’s the best part of paying taxes – It means you’ve made money! But did you know the type of entity you select can affect your taxes?
As we mentioned last Friday, we’re doing a series on four tax considerations that may help you pick the best business type for you and help your business become more tax efficient. The considerations are:
1. Pass through of gains
2. Pass through of losses
3. Transfer of assets to the entity, and
4. Transfer of assets from the entity
Last week we covered the S-Corporation. This week, we’ll cover the C-corporation.
What is a C-Corporation?
Usually, when people refer to a corporation, they mean a C-corporation. The C stands for the subchapter of the IRS code which governs the federal taxation of this type of entity. There are many benefits to having a corporate entity, such as the limited liability. For more info on the benefits of having a corporation, check here. As for the tax considerations, consider the following:
1. Pass through of Gains
With a C-corp, any gains or profits made by the company that are then distributed to the shareholders will be taxed twice. This double taxation imposes significant costs upon the transfer of money from the corporation to the shareholders. The average corporate tax rate in the United States is 35%. Further, the shareholder will pay an additional tax of 15% on dividends or distributions paid to them via the corporation. This can amount to a 50% tax rate on profits paid out to shareholders.
2. Pass through of Losses
A corporation is not able to pass losses through to shareholders. This could be a significant drawback when a shareholder wants to be able to write off expected losses. Generally, however, the corporation as an entity is able to carry their losses backwards or forwards and apply the tax benefit of a loss to future or past profits. This means that if a corporation realizes losses in one year and profits another, they are able to reduce the tax burden of the profitable year by carrying the loss over.
3. Transfer of assets to the entity
A major component of starting a new business is transferring assets to the corporation so it is able to conduct its business. Generally, if an asset is more valuable at the time it is transferred than when it was purchased, there would be a taxable event. For example, if property (land, buildings, and machines) were bought for $100, but are worth $200 when they are transferred to the corporation, the gain of $100 could be a taxable event for the original owner of the property.
There are complicated tax rules governing these “sales” of assets to corporations, especially if the person who originally owned the asset is not the only owner of the corporation. However, if the person(s) transferring the property owns 80% or more of the company at the time, then this isn’t an issue. If you think this applies to you, consult a licensed professional before making such transfers.
4. Transfer of assets from the entity to shareholders
As we saw above, when a company transfers gains to shareholders there is double taxation. Likewise, a transfer of assets from the corporation to a shareholder is subject to double taxation. For example, if the corporation is to distribute assets rather than money to a shareholder, the company would pay tax on any gain in value of that asset, and the recipient of the asset would also have a taxable gain on the asset received.
While starting a company may create complicated tax issues, choosing the entity that is right for you doesn’t need to be. Visit our Learning Center to see how easy setting up an entity can be!
Don’t forget, only 38 days left before April 17th!