Creative and tax-savvy business owners have many options available to attempt to lower their tax burdens. One of these options is the use of different business entities in order to escape at least part of their tax exposure, according to a recent Wall Street Journal report.
The Journal report outlined the case of RLE Technologies, a Fort Collins, Colo.-based entity that designs water leak detection sensors and web-based systems for monitoring facilities’ temperature and humidity. Currently, RLE is organized as an “S corporation,” meaning that the corporation “passes through” its income, losses and deductions to its owners.
The company posted $5 million in revenues in 2012, which passed through to its five shareholders. Because of RLE’s profitability, and its corporate structure, its five shareholders’ taxable incomes were much higher than their $100,000-per-year salaries, even though much of that revenue was reinvested into the business in the form of new equipment and staff salaries, not deposited into the shareholders’ pockets.
Now, though, RLE’s president, Chris Pullen, is considering changing the company into a “C corporation,” in order to reduce taxes. C corporations differ from S corporations not only in that they file their own tax returns and pay taxes based on corporate rates, but also allow for multiple classes of stock and an unlimited number of shareholders.
The timing is especially relevant now, as the tax rate on the highest-earning taxpayers rose from 35% to 39.6% in 2012. This category includes single filers earning more than $400,000 and joint files earning more than $450,000. With RLE posting 12% annual revenue growth, the company may soon generate enough profit to place its shareholders in that tax bracket soon. “The more taxes we pay, the less we have to reinvest,” Pullen told the Journal, in explaining his reasoning for considering the switch.
Corporate tax rates, which are the rates RLE would be subject to if it were a C corporation, are only 35%, at their highest, and may go lower. President Barack Obama recently proposed lowering the top corporate tax rate to 28%. Pullen told the Journal that, if Obama’s proposal becomes law, it would further entice him and his fellow RLE shareholders to change the company to a C corporation.
Switching to a C corporation is not without risk, however. C corporation profits can be double-taxed in some situations. If a shareholder takes money out of the corporation in the form of a dividend, the corporation pays taxes on that revenue on its return, and the shareholder pays income taxes on that dividend on his/her personal return. Double taxation may also be an issue when the shareholders sell a business structured as a C corporation. Business owners considering changing the entity to a C corporation must be certain of their decision. Once a business moves from an S corporation structure a C corporation, it typically must retain that structure for at least five years.
Businesses have a variety of options for their corporate structures. Each offers its own benefits and disadvantages, especially when it comes to taxes. The diligent tax attorneys at Samuel C. Berger, P.C. and CPAs at S.C. Berger, P.C. have years of experience helping business people throughout New York and northern New Jersey analyze their corporate structures and select a plan that offers the maximum benefit to them. To consult our attorneys and CPAs, contact us online or call (201) 587-1500 or (212) 380-8117.
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