New tax strategy
The Tax Cuts and Jobs Act (TCJA) was signed in to law on December 22, 2017, by President Donald Trump, after being passed by the House and Senate on December 19 and 20, 2017, respectively.
With legislation having only been in effect since January 1, 2018, there has been insufficient time for the accounting and business sectors to develop a best practice approach. We searched relevant journals, trusted media and industry experts and found many journalists and industry commentators - whilst offering suggestions to mitigate tax burdens under the new laws - also urging individuals and businesses to seek the advice of certified tax professionals to "develop the best strategy for 2018 and beyond."
The capital gains marginal tax rate in California is 13.3 percent and will remain in force until 2030. This is on top of federal taxes in capital gains at 20 percent for high net worth individuals and the 2017/2018 net investment tax of 3.8 percent. Those whose primary place of abode is in California will pay 37.1 percent for capital investments in 2018.
This adds to the complexity in determining the benefits of the TCJA for S corporation owners using profits from shares to fund their business. Experts recommend that a professional advisor be consulted to ensure the best outcome possible based on specific circumstances rather than generalized recommendations.
S CORPORATION VS C CORPORATION
Incentivizing business was a core goal for the TCJA with a number of new or changed business benefits for both S and C Corporations, including:
- "Indefinite net operating loss carry forward."
S Corporations, known as "non-corporate businesses" or "pass-throughs," were not directly taxed, with shareholders being personally liable for paying income taxes at individual rates. Though these rates could be as much as 42.3 percent for high net worth individuals, S Corporations were the preferred business structure.
Though S Corporations have moved to a temporary tax rate of 20 percent on "non-wage portions of pass-through income", the permanent reduction in the corporate tax rate to 21 percent together with fewer restrictions to allowable deductions makes C Corporations more attractive.
Tax benefits for C Corporations include:
- Fringe benefit deductions.
- Health insurance premiums.
- Fewer restrictions for service businesses.
- Repeal of "corporate alternative minimum tax."
Where S Corporation shareholders are also its managers, changing to a C Corporation would not see any significant alteration in reporting requirements if run as a closely held C Corporation whose stock is not publicly traded. However, if shareholders receive profits in the form of wages they would need to consider "business rates ... relative to ... labor income" rates.
Changing a business category from non-corporate to corporate can be as straight forward as lodging an 8832 form for states which accommodate "statutory conversions".
It is recommended that professional advice is sought before restructuring, particularly if statutory conversations are not available. Others recommend taking the time to quantify the savings to be made under the C Corporation tax reforms with high net worth individuals.
Cash donations to registered charities have been expanded to 60 percent, up from 50 percent of adjusted gross income. Those who can make larger donations will be able to benefit most from this change.
There appears to be benefit to moving to a C Corporation structure, however, advice from a tax professional is recommended to ensure any effort to reduce the tax burden is targeted to the actual circumstances of those involved.