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The Tax Cuts and Jobs Act (TCJA) brought about significant change for C corporations with its 21% federal income tax rate. However, there are still fundamental truths that apply to these corporations that are unchanged.
C Corporations are subject to double taxation
Corporate income is double taxed when it is first taxed at the corporate level, and again at the shareholder level as dividends are paid out. TCJA did not eliminate double taxation, but it has decreased in most instances due to the 21% corporate rate.
Double taxation does not apply when C corporations need to retain all earnings to finances growth and capital investments, because all earnings stay “inside” the corporation, and no dividends are paid to shareholders.
When income levels are low double taxation does not apply either. Maintaining low income can often be achieved by paying reasonable salaries and bonuses to shareholder-employees and providing them with tax-favored fringe benefits (as certain fringe benefits are deductible by the corporation and tax-free to the recipient).
C Corporation status isn’t always best
Ventures with appreciating assets
When a business holds appreciating assets or certain depreciable assets C corporation status isn’t advisable. For example, if assets such as real estate are sold for substantial gains, it may be impossible to extract the profits from the corporation without being subject to double taxation. Using a pass-through entity, such as an S corporation, partnership, or limited liability company treated as a partnership for tax purposes, prevents double taxation and allows gains on such sales to be taxed only once at the owner level.
Assets owned by C corporations do not always have to appreciate for double taxation to be required. Depreciation lowers the tax basis of the property, so a taxable gain results anytime the sale price exceeds the depreciated basis. This creates instances where depreciable assets holding their value can cause appreciation.
Ventures incurring ongoing tax losses
When a venture is set up as a C corporation, losses are not passed through to owners as they would be in a pass-through entity. Instead, losses create corporate net operating losses (NOLs) that can be carried over to future tax years and used to offset any corporate taxable income.
This has become an even greater drawback under the TCJA. It can take many years for a startup to be profitable, and under new policies, NOLs that arise after 2017 cannot be used to offset more than 80% of taxable income in the NOL carryover year. This means it will take even longer to fully absorb tax losses.
We can answer any questions you may have about C corporation status post-TCJA. Contact us at 949-860-9902 or click here, and we will contact you.