Should you Form a C Corporation?

By Tim Larason

Is it worthwhile to redirect your salary into a C corporation and take advantage of the low 21% tax rate? Not for most people. But for high earners, with personal income taxes at 35%, it might make sense.

Let’s assume you draw a salary of $600k. If you have other income equal to your standard deduction, your federal tax would be $153k leaving $447k. You would be willing to live on a salary of $400k and invest the remainder. If you have an employer willing to convert you as an employee into hiring your C corporation as independent contractor, this is how it might look.

Your employer pays your C corporation $600k on a Form 1099 for providing an executive level employee. Actually a bit more than $600k as your employer should pass on its  FICA and Medicare tax savings. The contract can’t designate you and you only or else you have a personal holding company with added tax. Your corporation could pay you a salary of $400k. This would reduce your personal tax from $153k to $83k, a savings of $70k (you are in a 35% marginal bracket). The $200k left in the corporation would have a corporate tax of $42k at the 21% rate. So the net savings would be $28k. If you now have employment expenses not being reimbursed that are nondeductible under then new law, those could be paid by your  corporation on a tax deductible basis.   

If you choose to distribute the $158k as a dividend, your personal tax on that would be the capital gains rate of 20% plus the net investment income tax of 3.8%, a total of $48k. So that is no good.

But here is a better plan. Take the $158 after tax and invest it in a side business. To avoid problems with the accumulated earnings and personal holding company penalty taxes, it must go into an active business, not stock and bonds. Perhaps buying, repairing and reselling houses. After five years you have accumulated $800k in the restoration business. You retire from your salary position and leave the stock to your spouse or children on your death. The tax basis of the stock is stepped up to $800k so the corporation can then be liquidated for that amount with no tax. Your heirs inherit the $28k annual tax savings, $140k. However if the corporation ends up with appreciated assets, there would be a corporate tax on the appreciation.

If you made a cash investment to start the corporation, you could possibly qualify to sell the stock after five years and before death tax free under Section 1202 for Qualified Small Business Stock. The exclusion would be limited to ten times the original investment and is subject to other rules.

There would be many details to work out. Maybe your corporation would need to set up its own retirement plan. To avoid tax challenge to this plan, you probably should not be an officer of your employer but being a board member is probably OK. First year start up expenses would be more than nominal. If you would like to explore the options and benefits of forming a C corporation, please feel free to contact me or one of the capable business/corporate attorneys at Andrews Davis, PC.

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