Year after year, the question I’m asked the most has to do with business structures. Have you wondered if you have the right business structure for your business or your investments? And especially with the tax changes due to the Trump Tax Plan in 2018. What now?
There are plenty of reasons to be concerned if you have the wrong business structure.
Consider the case of Greg. His father started a retail business 30 years before. He was now taking over the reins, and the ownership. The business was going through a lot of changes and one of the things he wanted to do was pay attention to the potential risk. The business had grown to 6 different locations. And, over time, as the business prospered, the dad had bought the buildings where the stores were located.
Now, with online shopping making big inroads into their business, they needed to do something else.
He had some offers to buy the buildings and since they didn’t have much debt, it made sense to sell. The businesses should go online to stay inline with competition. Operating costs would go down and hopefully sales could stay the same.
But now he faced a major tax issue. His dad had held all of the real estate and the businesses inside a C Corporation. Just one C Corporation. The tax consequences of selling an appreciated asset that had both gone up in value and depreciated on the tax return would mean a low basis and a whole lot of taxable gain.
One good thing was that the C Corporation tax rate had dropped in 2018, so the tax hit wouldn’t be as bad as in the past. (The drop was from 35% to 21%. There is no capital gains tax rate for C Corporation.)
But then he was faced with the question of how he got the proceeds out of the C Corporation. If he closed down the C Corporation, he’d have liquidating dividends subject to double taxation. If he left the money inside the Corporation, how would he get it? He could take it out in salary, but that would create a loss with no operating company and losses could no longer be carried backwards. In effect, it would be double taxation again.
He needed a strategy and he needed one quickly because he was about to close the first sale.
If Greg came to me with a similar plan today (building out stores and owning the real estate), we would have set up the real estate separately from the business operations. In that way, the property could be transferred or sold without having these C Corporation issues.
For over 30 years, we’ve been conditioned to be very careful with using C Corporation. Now with the lower C Corporation tax rate, it’s become more popular. In fact, for the first time since the 1986 Tax Reform Act, I’ve been advising professionals to use a C Corporation. If your income is so high that you can’t take advantage of the 20% income deduction for pass-through entities, a C Corp may provide a lower tax bracket. But if you need every penny of it for living expenses, then it means you’ll pull it all out in the form of salary. If that’s the case, you don’t save because you end up with payroll taxes and the income is all reported on your personal tax return anyway.
What does all of this mean?
The times have changed. Don’t assume your old tax strategies are going to work. You may need to have a new business structure or change how you use the existing one.
If you don’t want to wait until tax season to find out what you should have done, contact us today to set up a consultation. You can give Richard a call at 888-592-4769 or go directly to https://www.ustaxaid.com/consultation/.