C corporations have a reputation as the worst option for keeping your taxes low. Is that really the case? Those who disparage C corporations typically point to one significant downside: double taxation. In a C corp, business income is taxed first at the entity level and then again at the individual shareholder level. With double the income tax, it’s hard to imagine a C corporation being a tax-advantaged choice. Case closed?
The verdict here is actually much more nuanced. Savvy business owners know that every entity choice comes with benefits and drawbacks. Despite the default double taxation, C corporations also enjoy special tax breaks and enable certain tax strategies that are not available to other entity types. Did someone say “qualified small business stock”? This reveals a foundational truth of tax planning: the right entity type comes down to which tax advantages yield the highest savings for your specific business.
Find the Right Tax Levers
So if you have a C corporation (or are thinking of becoming one), how can you dodge that double taxation trap? As with any tax plan, you want to start by looking at the six basic tax levers: income shifting, deductions, loopholes, rates, investment strategies, and tax credits. Each of these levers functions differently within different entity types. So the first step is to understand where the tax savings options lie within a C corporation.
Where the C Corp Shines
If you can maximize these C-corp-specific tax strategies, you may find that a lower tax bill is indeed within reach:
- Income recharacterization. C corporations enable easy income recharacterization. Though shareholders do pay a second round of taxes, you may qualify for the lower capital gains tax rate if you hold onto the stock long enough. If the stock meets the “qualified dividends” requirements, shareholders may only pay a 20%, 15%, or even 0% tax rate. C corporations are the only entity type that can make use of qualified dividends.
- Special loopholes. When we say “loopholes” here, we are not referring to shady attempts to evade taxation. Legitimate loopholes are created by the IRS to benefit certain types of businesses whether that’s through a direct tax break or making these businesses more appealing to investors. A great example is the ever-popular qualified small business stock (QSBS) tax exemption. Small C corporations may qualify to offer this major benefit to investors: no federal capital gains tax on the sale of up to 100% of their stock.
- The flat 21% corporate tax. If you or other shareholders are already paying the top 37% personal income tax rate, that 21% corporate tax rate may become much more attractive. As long as business income stays in the C corporation, it will only get hit by that 21% tax—until you distribute it. Of course, there’s a limit to how long you can “hold” income in a C corp, but this option can allow you to choose the most tax-advantaged moment to pay your shareholders.
Where the C Corp Hits Limitations
Before deciding to stick with a C corporation, make sure you’ve weighed the cons as well as the pros:
If you’re attracted by the QSBS benefits… keep in mind the date your C corporation was formed and when your stock was first issued. Only stock acquired after August 10, 1993 can qualify as QSBS. However, if it was acquired before September 27, 2010, the stock is only eligible for a 50% capital gains tax exclusion. Afterward, the benefit shifts to a 100% exclusion if the stock meets the other criteria.
If you’re drawn in by that flat 21% tax rate… keep in mind that Congress has anti-deferral rules in place. However, these rules largely apply to passive income and especially to investments in overseas companies. If you have a plan in place for when to make distributions, you can avoid potential penalties.
No one strategy offers limitless tax savings, so at the end of the day, it’s all about figuring out which ones yield the biggest benefits for your specific business.
Make Your C Corp Work for You
At the American Institute of Certified Tax Planners, we know where to find hidden tax savings—no matter your entity type. By looking at tax planning as a system, we avoid the trap of categorizing certain entities as “low tax” and others as “high tax.” Instead, our tax planners create customized plans that take your priorities into account and make the recommendations that will best serve your needs. To get started today, reach out to a Certified Tax Planner.
