Angling for the Best Tax Rates
C corporations are not known for being tax-advantaged. However, the reality is that any entity type comes with pros and cons when it comes to tax planning. The key is knowing how to navigate the nuances of that entity type. For instance, C corporations struggle with a double taxation problem—income is taxed once at the corporate level and again once that income is distributed to shareholders. On the other hand, the corporate tax rate currently stands at 21%, which can be an attractive rate for taxpayers who normally pay a 32%, 35%, or 37% tax rate on their income.
How can a taxpayer take advantage of that lower tax rate and avoid double taxation? The key is knowing the tax strategies that are unique to C corporations, like the tax perks that come with contributing assets to the business.
Know the Right Questions
Under the right circumstances, a shareholder can contribute an asset to a C corporation tax-free. This could be anything from real estate to stock to equipment the business might use. If you are considering recommending this strategy to a business owner, be sure to ask these questions first:
- Did the asset previously belong to a business (including a sole proprietorship), and did the business receive depreciation deductions on it?
- What will the shareholder receive in exchange for contributing that asset?
- Is the business planning on keeping the asset, selling the asset, or ultimately distributing the asset back to the shareholder?
Knowing the answer to these foundational questions is necessary to help you plan for potential tax consequences.
What to Know Before Contributing an Asset
Before a client contributes an asset to their C corporation, help them to pause and consider how this move might affect their taxes.
If the asset has previously been depreciated… keep in mind that the depreciation history does not just vanish when the asset is moved into a C corporation. If the asset has been depreciated, then its adjusted basis is now lower. This can result in a major gap between the tax basis of the asset (from a tax perspective) and the fair market value of the asset. Does this mean the corporation will have to pay tax on that contribution? It depends…
If the contributing owner holds at least 80% of the company’s stock… they may be eligible for a tax-free contribution. The key here is that the sole proprietor must receive 100% stock in exchange for that asset. This satisfies the requirements of Code Section 351 and makes the transfer tax-free. The asset will also stay at the same value—whatever the current tax basis is.
If the C corporation sells the asset… the gain will simply be the difference between the current value ($60,000) and the sales price. The C corporation will pay tax on that gain at the 21% tax rate. Another tax strategy may come into play if there is recapture because the IRS determines that you enjoyed more depreciation deductions than you should have received based on the sales price of that asset. If an individual sells an asset, recapture is taxed at ordinary income tax rates, up to 37%. If a C corporation sells an asset, recapture is just taxed at 21%.
If the C corporation gives the equipment back to the shareholder as a property dividend… you could owe two levels of tax. If the corporation sells the asset at fair market value and that value is higher than the adjusted basis, you’ll get hit with the corporate level tax. But you may also get hit with individual income tax when you distribute the property to the shareholder. It all depends on the circumstances, such as the shareholder’s stock basis and whether this is just a distribution or the C corporation is actually liquidating.
Always Weigh the Consequences
Tax savings and tax deferral opportunities are available to C corporation shareholders if they understand the rules. Not all taxes are avoidable, but in some situations, contributing an asset to a corporation can reduce the taxes paid on recapture or delay the moment when they have to pay tax so that they can wait until taxes will be lower. In every situation, advance planning is essential. Make sure your clients are aware of the sneaky taxes that can pop up before they make a big move like contributing or selling an asset.
Become Well-Versed on Every Entity Type
Tax planners need to know much more than what deductions and credits exist or how to fill out a Form 1120. The American Institute of Certified Tax Planners takes you deeper into the world of tax planning for entities, so that you can expertly craft customized tax plans whether you are working with C corporations, S corporations, partnerships, or sole proprietors. We teach you the tips you need to know, but we also emphasize being thorough. The tax planners who know the signs to look for can secure major savings for their clients and charge the premium rates that allow them to focus on fewer clients.
Learn the ins and outs of tax planning for every entity type. Sign up to become a Certified Tax Planner today!
