David Knoble, CPA, PLLC

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Is Your Small Business a C-Corporation?

C-Corporations are typ­i­cally reserved for larger, multi-owner com­pa­nies.  Pub­lic com­pa­nies are almost always C-Corporations and for good rea­sons.  How­ever, a small busi­ness fre­quently has more tax advan­tages as an LLC, Part­ner­ship or an S-Corporation.  That being said, now may be a good time to move away from your C-Corporation structure.

Why move from a C-Corporation?  First, a C-Corporation car­ries an accu­mu­lated earn­ings tax, or AET.  In it’s sim­plest form the AET taxes a cor­po­ra­tion for leav­ing too many prof­its con­tained in the cor­po­ra­tion.  Since a C-Corporation has a lower tax than indi­vid­ual rates, leav­ing money in the cor­po­ra­tion avoids the sec­ond level of tax­a­tion by issu­ing a div­i­dend.  The IRS doesn’t like that!

Sec­ond, rates for cor­po­ra­tions and div­i­dends have been lower for sev­eral years.  If con­gress does not react, then 2010 will likely be the last year for these lower rates.  As the rates increase, the advan­tage of lower cor­po­rate taxes ver­sus a part­ner­ship dimin­ish.  In fact, cou­pled with the AET, tax rates can be much higher than part­ner­ship rates.

Then what hap­pens if you change to an S-Corporation or other entity?  Typ­i­cally, chang­ing from a C-Corporation to any other form except an S-Corporation causes an imme­di­ate tax lia­bil­ity.  This doesn’t mean the change may not be advan­ta­geous going for­ward, but it will cost cash.  Chang­ing to an S-Corporation takes some tax­able income and holds it for 10 years.

Dur­ing the 10 year period, if any of the inven­tory or assets moved over from the C-Corporation are sold, then the accrued tax­able income is taxed as if it were C-Corporation prof­its that were div­i­dended.  To the extent that these assets are held for 10 years, this accrued amount goes away.

How can this apply to a small busi­ness?  Even with this strange 10 year hold­ing period, most small busi­ness will ben­e­fit in the long run from mak­ing a change.  Today, real estate com­pa­nies can ben­e­fit the most.

Real estate val­ues are his­tor­i­cally low, some­times even less than the cost of the real estate.  Thus, this 10 year accrued cor­po­rate tax­able income is low or elim­i­nated.  As the real estate increases in value, the new prof­its are locked in at S-Corporation rates and passed through to the own­ers.  There­fore, the higher C-Corporation rates almost disappear.

If you have a small busi­ness that is a C-Corporation, con­sider talk­ing with your CPA to deter­mine if you should make a change.  You can make the elec­tion for 2010 between now and March 15, 2010 if you are a cal­en­dar year C-Corporation.

© 2009, david.knoble
by David Kno­ble, CPA, PLLC
Serv­ing Non-Profits, Busi­nesses & Indi­vid­u­als
Rock Hill, SC

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