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Friday, February 22, 2013

C Corp Preference Even Before Possible Rate Reduction?

A Wall Street Journal article published this week - "Small Businesses Puzzle Over Tax Riddle," by Emily Maltby (2/20/13), states that some small business owners are considering converting to C corporation form now.  Today, the top C corp rate is 35% and the top individual tax rate is 39.6% (20% on capital gains; or really 23.8% on capital gains with the Medicare tax).

So, if your sole proprietorship, S corporation or partnership or LLC generates over $400,000 of income, the C corp rates look good. They look even better than the 35% top corporate tax rate because that doesn't kick in until the corporation has over $10 million of income. With $400,000 of income, the C corp is in the 34% bracket with the first $50,000 taxed at 15% and the next $25,000 taxed at 25%.

The WSJ article also refers to a recent WSJ/Vistage International poll of 848 small businesses where 35% said they would consider the C corp form if the corporate rates were reduced from the current top 35%.  Remember that Congressman Camp wants a 25% top rate and President Obama has called for 28% and even lower for advanced manufacturers.

But, there are downsides of the C corporate form, namely double-taxation of income. That is, when the corporation issues a dividend, the shareholder pays tax on that income (which was already taxed to the C corp when earned).

Policy considerations:
  • Should all businesses be taxed similarly?
  • Why have double taxation for C corporations? (an integrated tax system can be complicated to get to)
  • Can/should Congress lower the corporate tax rate while leaving the top rate 39.6% for all other businesses?  While few businesses have income in excess of $400,000 for each individual owner, it is still the possibility of that higher rate that would leave a significant tax discrepancy.
  • Is elimination of most tax preferences to get to a 25% corporate tax rate helpful to businesses and the economy?  Preferences that likely would go would be rapid depreciation, expensing research expenditures when incurred and the research tax credit.
What do you think?

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