C corporations, which are required for 401(k) business financing, have many benefits that make them the business entity of choice for some tax professionals, including a lowered corporate tax rate under the 2018 tax reform legislation.
In the process of using your retirement funds to open a new business or purchase a franchise (formally known as a Rollover for Business Start-up), you must first open a C corporation. While some CPAs and investment firms may recommend that businesses immediately or eventually be converted to S corporations, there are actually many advantages to the C corporation for new business owners. In fact, many tax professionals recommend the C corporation as the business entity of choice.
While some tax advisors advise against C corporations for small businesses based on “double taxation” issues, many small businesses have little left in the way of earnings after salaries and fringe benefits are paid out. Little or no earnings mean little or no corporate taxes or double taxation issues. Additionally, you should weigh the double taxation issue against many other factors, including the fact that you might be able to delay receiving dividends and paying taxes for several years.
Consider the following benefits of a C corporation:
- Profits from a C corporation do not pass through to the individual owners, and therefore do not affect individual tax brackets. Profits remain in the company and are taxed at the corporate rate – which was reduced from 35% to 21% under the 2018 tax reform.
- C corporations can take virtually unlimited capital and operating losses, which means the IRS will not scrutinize you if you report losses many years in a row. You can carry losses forward or backward and apply them against other tax years, allowing you to substantially reduce your tax bills. This is especially important for a new business start-up that may take substantial losses in the first year but wish to carry them forward to future years.
- A C corporation’s income is taxed at a 21% flat rate. By comparison, any individual with taxable income of $38,700 or more will be taxed at least 22%, if not more, depending on their tax bracket.
- In small, privately held corporations, shareholders may also serve as the corporation’s directors and employees. Employees are entitled to salaries, and the corporation can elect to pay enough in salary and bonuses so no taxable profits remain at the end of the fiscal year. As a result, shareholders will only pay individual income taxes.
- C corporations can deduct 100 percent of the health insurance they pay for their employees, including employees who are shareholders in the corporation. They can also deduct the costs of any medical reimbursement plans. For a small corporation with a lot of medical expenses that aren’t covered by insurance, the corporation can establish a plan that results in all of those expenses being deductible.
- Unlike LLCs or S corporations, the fiscal year for a C corporation doesn’t need to correspond with the calendar year. One advantage of this is “income shifting,” which allows the owner to decide which year to be taxed on bonus money.
As always, if you have specific taxation questions, it’s best to consult your tax professional.