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C Corp vs. S Corp – Comparison After 2017 Tax Reform

C Corp vs. S Corp – Comparison After 2017 Tax Reform

Mar 22, 2018

As the snow begins to melt in some places, we are exploring various parts of the 2017 tax reform that impact agriculture. In this article, we’ll address the question of C corporation or S corporation. This comparison, which is an option for most producers, has a new twist because of the changing tax rates, a few different rules, and the prominent new Section 199A deduction. 

Speaking of the 199A deduction, the nearly “nationwide confusion” that was caused by what many consider to be an unintended wording slip in the new tax code has not been resolved as of press time. Congress and the IRS are both working to find a way to “correct” the unintended interpretation that seems to significantly favor marketing-based cooperatives vs. non-cooperative-based purchasers of commodities.   

Let’s examine the C corporation vs. S corporation analysis by comparing three examples. The examples all start with an amount that we’ll call net internal business income. For this article, this term refers to the net income generated by a farm or ranch before any deductions for owners’ salary, rent to owners for use of their assets, and owners’ lodging and meal expenses. These examples assume a married couple with no dependent children and no income from off-farm sources. 

   Example 1 Example 2 Example 3
 Net internal business income  $100,000  $200,000  $300,000
 Wages to owners  20,000  40,000  60,000
 Rent to owners  30,000  40,000  60,000
 Housing expenses  12,000  20,000  30,000
 On-farm meals expense  8,000  10,000  12,000

Tax if Organized as a C Corp      
Corporate Tax                  $7,140       $19,950     $30,240
Individual Tax  2,739  6,339  12,999
Total Tax  9,879  26,289  43,239

Tax if Organized as an S Corp        
Corporate Tax                $0               $0              $0
Individual Tax 7,539 25,319 46,179
Total Tax 7,539 25,319 46,179
Cost (savings) if a C Corp   2,340 970 (2,940)

 

What causes the differences in the examples above?  There are a variety of factors, including:

  • Tax rates applicable to C corporations and individuals at various income levels
  • C corporations now being taxed at a flat rate of 21%; individual rates of 10%-37%
  • Nondeductibility of housing and on-farm meals by non-C-corporation taxpayers
  • Section 199A deduction (20% of net business income) by non-C-corporation taxpayers
  • The allocation of income among the C corporation and its owners
  • Sources of off-farm income (The examples above assume no off-farm income.) 

As many producers evaluate what type of corporate entity to use, here are some other factors to consider:

  • With proper structuring, C corporations can deduct medical expenses of owners, while S corporations cannot.
  • Very large profits result in an advantage to having a C corporation structure in place.
  • Very large profits can result in the limitation of the Section 199A deduction.
  • Larger amounts of housing and on-farm meal expenses favor a C corporation.
  • Family size may impact the analysis.
  • Exit and/or transition strategies may favor an S corporation if a future sale is anticipated.
  • The potential for double taxation still exists with a C corporation, although the cost is reduced by the reduction in corporate tax rates.

So Now What?
There are likely other very situation-specific factors that apply to each individual case. As we assist clients in this strategic analysis, it is clear that a one-size-fits-all strategy does not work. Each producer’s circumstances and future plans need to be carefully considered when choosing your type of business entity. 

As you meet with your tax advisor to wrap up your 2017 returns, you should consider discussing your situation in 2018 and beyond. If you have questions or would like to discuss this or other income tax strategies, please contact us.

Author(s)

Curtis Barnekoff
Curt Barnekoff, CPA
Partner
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