TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, February 22, 2013

WSJ: New Tax Riddle: S or C?

Wall Street Journal:  New Tax Riddle: Pick S or C:

Business owners can't change the tax code, but many of them say they might change the way their businesses are structured in order to pay less tax. ...

This year personal income-tax rates for the highest earners—single filers exceeding $400,000 and joint filers exceeding $450,000—rose to 39.6% from 35% in 2012. ... The top corporate-tax rate, by contrast, is 35%, though it might decline if Congress overhauls corporate taxes. ...

Thirty-five percent of 848 small-business owners and chiefs surveyed by The Wall Street Journal and Vistage International, a peer-advisory firm for CEOs and senior executives, said they would consider reorganizing into C-Corporations if corporate-tax rates were cut. ...

Ninety-five percent of all business entities declare business profits on their owners' personal tax returns, according to an August 2012 report from Congress's Joint Committee on Taxation. Some experts say C-Corporations may not significantly lower these business owners' tax bills—and might raise their tax burden.

"Even though on the surface you're looking at 35% versus 39.6%, it's a deceptive comparison," says Robert W. Wood, a tax lawyer with Wood LLP in San Francisco. "There may be a slight short-term advantage in C-Corporations, but there are a number of negative long-term implications that would outweigh short-term benefit."

For example, C-Corporation profits can be double-taxed. In addition to the corporate tax on profits, owners also would owe personal taxes on any money they take out of the company as dividends. The double tax kicks in when a business is sold, too.

Another potential problem is that a firm that switches from an S-Corporation generally has to remain a C-Corporation for at least five years....

In the survey, 29% said they wouldn't consider reorganizing into C-Corporations, even if corporate tax rates fell.

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If there is a shift from S to C corporations, the statistics on reported taxable income will show a decrease for high-income taxpayers. Then the income inequality scolds will face a choice: (a) declare the higher personal income tax rates a success at reducing inequality or (b) attempt to make an adjustment for the shift.

Choice (a) is intellectual dishonest, since the underlying reality is not changed. Choice (b) would illustrate that failing to make the opposite adjustment for pre-1986 data was intellectually dishonest.

The best choice is (c) admit that the shift exaggerates the reduction in inequality to the same extent that previous studies exaggerated the increase in inequality.

Posted by: AMTbuff | Feb 22, 2013 10:42:02 AM