Why S Corporations Are Still Advantageous for Small Business Owners, Part 1 – Los Angeles Income Tax Planning and Income Tax Litigation Attorney Bruce Givner

by Bruce Givner on February 13, 2014

As we discussed in a previous post, recent changes to the highest individual tax rates have led some to question the conventional wisdom regarding the benefits of filing as an S corporation. With the American Taxpayer Relief Act of 2013 raising the highest individual tax rate to 39.6% from 35%, many businesses and tax professionals are wondering whether it wouldn’t be better to revoke the election under Subchapter S of the Code in order to avoid these new, higher tax rates. In this post, we’ll review one of the three major reasons why S corporations remain a better choice for businesses.

The first reason why S corporations are still a good idea is that tax rates aren’t everything. With the highest federal income tax rate for individuals now 4.6% higher than that of the highest corporate tax rate, it may appear at first blush that trading in your S corporation for a C corporation would make more sense for those small businesses and startups looking to avoid the new, higher rates. By restructuring their business entity in order to benefit from the lower corporate rate available for C corporations, these businesses would be able to reduce their overall tax obligation. However, this simplistic analysis ignores the larger picture.

First of all, as S corporation shareholders can also be classified as employees of the business they can draw salaries from the company as well as receive dividends and other distributions that are tax-free to the extent of their investment in the corporation. By reasonably characterizing the distribution of salary or dividends, the owners can reduce the self-employment tax liability and generate business-expense and wages-paid deductions for the corporation.

Also, unlike a partnership or an LLC, S corporations have much more straightforward rules when it comes to the transfer of ownership. S corporation ownership interests can be transferred freely without prompting unfavorable tax consequences. For partnerships and LLCs, however, the transfer of more than 50% interest can result in the termination of the entity.

Clearly, despite the increased individual income tax rates, S corporations still hold significant benefits for small businesses. The decision to change your business’s entity status from an S corporation must, therefore, consider more than simply the applicable tax rates. Stay tuned for part two where we will discuss yet another reason why S corporations remain advantageous to small business owners.

Givner & Kaye focuses on sophisticated income tax planning and compliance, tax litigation and procedure, estate planning, and asset protection plans for individuals and businesses in Beverly Hills, Calabasas, West Los Angeles, Hollywood, and other areas of Los Angeles, Orange, Ventura, San Bernardino, Riverside and Santa Barbara Counties. Call Los Angeles Estate Planning and Asset Protection Plan Attorneys Givner & Kaye at (310) 207-8008 today.

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