The C Corporation Double Tax Issue

Are you thinking about setting up a C Corporation to offset some of the higher taxes you’ll face in 2013? Have you been holding off because you’ve heard about the double-taxation issue that goes with C Corporations? Well, it may not be as bad as you think.

Double taxation is something unique to C Corporations. It happens because C Corporations are the only business structure that pays taxes at a separate, corporate income tax rate. The other structures, S Corporations, LLCs and Limited Partnerships don’t pay separate income tax. Even though they prepare tax returns, the actual end profit and loss numbers are flowed through directly to their owners’ tax returns. That’s where the taxation happens, which is why, in flow-through entities, your business profit is only taxed once.

But in C Corporations, it all changes. First, the Corporation calculates its net taxable income, then it pays taxes on that income. Those rates are lower than personal tax rates, at least for part of the income. After the tax has been paid, the net after-tax profit can be distributed to the owners, in the form of a dividend. When you take out that after-tax profit from your Corporation as a dividend you have to report the money on your personal tax return, where it is taxed again – this time as the current tax on dividends.

On the face of it, that sounds like a bad thing – tax at the company level, plus tax again at the personal level. But the truth is, there are times when that combined tax is going to be lower than your personal tax rate. This is especially true if you are already paying tax at the top level.

The base tax rate for C Corporation income is 15% on the first $50,000 of income. The dividend rate is currently 15% (although we’re expecting this to increase next year). Yet the top federal personal tax rate is 35% right now, and may go up to 39.5% in January. With some careful planning, you can adjust your earnings through the C Corporation to take advantage of lower rates, and lower your overall tax bill.

Is a C Corporation for you? The answer will need to come from you, probably after talking to your tax advisors. But with AMT and other tax changes looming for 2013 (above and beyond what we’re talking about here), it’s going to be a conversation worth having.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

Got questions? Contact us! We’re here for you.

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