The new tax law, put in place 1/1/2018, is causing ripples throughout the tax industry. Even though we’re well into the second year of the new law, there are still plenty of cases where an update to the tax structures is desperately needed.
Here’s a “That was then, this is now” case of how we can do something we never dreamed we’d be able to do again.
I like to call this “Michael and the Amazing C Corporation”
Prior to 1/1/2018, a C Corporation had a graduated tax rate, just like your personal income tax return. The first $50,000 of taxable income inside a C Corporation was taxed at 15%. After that, the rates went up rather quickly. But that first $50K, that was a gift to high-taxed individuals who could make use of a C Corp.
That seemed like a loophole that Michael, my client wanted to use to his benefit. Michel made a high income as a real estate broker specializing in commercial buildings. His clients were large national and multi-national pension companies and he looked all over the US for investments that met their criteria. When he found one that his buyers liked, the commissions were huge.
He also was single and just lived for his work. No expensive hobbies or addictions, for that matter. He had a nice house, but nothing fancy. His one Indulgence were high end luxury cars, but he used those for business so at least part of the expense was a write-off.
He didn’t have any dependents that he supported.
He just made a lot of money and didn’t spend much, outside of his business. In fact, every year, he banked about $250,000 after he took advantage of the maximum pension contribution that he could put aside. What now? He wanted to pay less tax.
He made all of his Income in the US, so advanced offshore tax strategies weren’t going to work. (We’re talking JUST the legal ones. Undoubtedly, you could find an illegal one that would work If you didn’t mind the risk of jail time. Yikes!)
All of his income was personal Income. We put him in an S Corporation to lower the self-employment tax. He easily hit the maximum Social Security Income level so there was no additional Social Security tax, but the Medicare tax goes on without a threshold. So that was saved with the S Corporation, but it wasn’t a lot.
That’s when I brought up the concept of a C Corporation. Pre-2018, the first $50,000 was taxed at 15% and his personal income marginal tax rate was 39.6%. So, at least for $50,000 he saves the difference (39.6 – 15.00 = 24.6%) times $50,000. That meant a savings of a little over $12,000.
Of course, there was the additional cost to Initially set up the C Corporation, keep separate books and records and prepare an annual C Corporate tax rate. But all in, that was less than $1,000 ongoing, so he put $11,000 In his pocket. ($12,000 – $1,000)
Michael thought that was great, but then, without my knowledge, he supersized It! He didn’t need to spend $250,000 per year, so he could afford to set up 5 C Corporation, so he now had a net of $11,000 times 5! Come tax time, he was so proud of the choices he’d made and how he’d taken my Idea to save himself $55,000.
Unfortunately it didn’t work, the problem was controlled groups.
If you had similar (or in his case, the same) ownership, you couldn’t take advantage of multiple tax brackets. You had to consolidate them all for one big tax return. It was actually a pain because you had to prepared all the Individual ones and then consolidated them for one big one.
Michael’s plan didn’t work. And now, that $50,000 threshold amount would be taxed at a flat 21%. But so will all the rest of the income. There are no brackets or thresholds anymore everything is taxed at 21%. Michael’s highest marginal tax rate has been reduced to 35%, andthat means that he can save 14% on the entire $250,000. That’s a total savings of $35,000 by using the C Corporation. Not quite the $55,000 Michael had initially wanted but more than he ended up with!
He’s also a little older and it’s time to look at some different options for his pensions. Since he’s the only employee, he may now be eligible for a defined benefit plan. One of my clients is putting away over $180,000 a year in his, all tax deductible. The downside of pension plans Is that you avoid tax now, but there is a tax bill later. The theory is that later when you take the money out, you will be in a lower personal tax rate. That’s the goal anyway!
Have you kept up to date on your tax planning? Maybe it’s time for a business structure refresh. I currently take 4 tax consultations a month. Two of those spots are already sold this month, so there are just 2 left.
Interested? Contact Us.