February 2015

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February 2015 | Construction Equipment Distribution | www.cedmag.com | 47 >> CFO 411 STEVE PIERSON C Corporations Reconsidered Thanks to tax increases in 2012's health care law, S doesn't always stand for 'smart' anymore. M any small businesses operate as either an S corporation or partnership. is has made good sense from a tax plan- ning point of view, as the income is taxed only once to the shareholder or partner. But consider this: Since 2013, individual income taxes have taken a sharp hike with the American Taxpayer Relief Act of 2012 by: increasing rates for individual taxpayers with adjusted gross incomes above $406,750 and married taxpayers filing jointly with AGI above $457,600 to a 39.6 percent rate; increasing the capital gains and dividend tax rates for taxpayers who exceed the income thresholds listed above increase from 15 percent to 20 percent, and adding a cap on itemized deduc- tions and personal exemptions for those making $250,000 (married couples making $300,000). Furthermore, there is an additional tax on invest- ments of 3.8 percent for individual taxpayers with adjusted gross income over $200,000 and joint filing taxpayers with adjusted gross income above $250,000 under the Health Care Bill. Given the new higher individual tax rates described above, it may be time to re-examine the use of C corporations as an advantaged cost savings structure in which to operate your business. Below are some factors in helping an owner or executive in making this decision. C corporations have a tax rate that is now lower than that for high-income individuals. e first $50,000 of taxable income is taxed at 15 percent and the next $25,000 is taxed at 25 percent. e rates are structured so that as taxable income increases the corporation pays a flat 34 percent up to $10 million. However, remember that with a C corporation there is a "double taxation" of income both at the corporate and shareholder level. A business owner/employee can plan for use of the 15 percent and 25 percent lower corporate rate by paying a salary at a level that brings the corporate income down to utilize the lower rate instead of that same income being taxed at the 39.6 percent rate. In addition, C corporations are not subject to the 3.8 percent investment income tax described above. In the case of an equipment rental business, the tax law has created a problem for owners that operate as a partnership or S corporation. e rental business is treated as a passive busi- ness despite the time and effort the owner puts into the business. If a business is considered passive, any losses derived from that business cannot be used to offset income not considered passive nor carried back to prior years. Poten- tial exceptions to this rule are when the rentals average 30 days or less or the rental operation is considered de minims to total operations. e passive loss rules do not apply to C corporations and may be a significant factor in deciding whether to use a C corporation. C corporations offer a reduced rate of capital gains tax on the sale of qualified small business stock (QSBS). QSBS is generally stock held at least five years in a qualified trade or business but not certain personal service businesses. Currently, owners of QSBS can exclude 50 percent of the gain on the sale if the shares were acquired aer Dec. 31, 2014. e maximum gain that can be excluded is limited to the greater of $10 million or 10 times the taxpayer's basis in the stock. e tax rate on the reported gain is subject to a 28 percent tax rate, or an effective rate of 14 percent on the entire realized gain. Taxpayers who obtained QSBS between Sept. 28, 2010 and Dec. 31, 2014 can exclude 100 percent of the gain on that stock. We have only scratched the surface on C corporation considerations. Certain employee benefits and compensation bonus structures are available to C corps that aren't available to pass through entities. And remember, the key is not only the present status of the busi- ness but the ultimate goal in transfer or sale at retirement or death. STEVE PIERSON is vice president and a shareholder of Selden Fox, Ltd. He has more than 30 years of experience as a tax professional in public accounting, specializing in technical accounting, tax, financial, estate and succession planning, employee benefits, international tax planning, merger and acquisition transactions, and compliance for medium-sized businesses. He can be reached at pierson@seldenfox.com. "... it may be time to re-examine the use of C corporations as an advantaged cost savings structure in which to operate your business."

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