Corp! Magazine - April 2022

All businesses, whether large or small, should frequently evaluate strategies for minimizing their overall tax burden. Here are a few tips that businesses may consider implementing to achieve such tax savings.

Choice of Entity

Determining the type of legal entity used to operate a business is a crucial decision with significant tax and other legal implications that every business owner should regularly consider. For tax purposes, an entity may either be taxed as a “pass-through entity” or a C corporation. A pass-through entity is a business structure where no tax is imposed at the entity level. Rather, the income/loss of the business is reported directly on the owner’s tax return. A sole proprietorship, partnership and S corporation are all examples of pass-through entities.

On the other hand, a C corporation is taxed directly on its earnings and the owners are subject to an additional tax upon receiving dividends from the C corporation. This second level of tax is often referred to as “double taxation.” The Tax Cuts and Jobs Act of 2017 (TCJA) reduced the income tax rate for C corporations from a top progressive rate of 35% to a flat 21% rate and individuals are subject to a top rate of 37%.

Although the tax rate imposed on C corporations is generally lower than the highest individual tax rate, it is important to keep in mind that shareholders will bear an additional burden of tax on dividends paid by the C corporation. Dividends are taxed at a maximum rate of 20% but may be subject to an additional 3.8% net investment income tax. After considering the double tax imposed, the tax burden for C corporations and its shareholders is 39.8%. Thus, if a business owner expects to receive frequent distributions of earnings from the business, then operating as a C corporation will likely result in a higher overall tax burden than if the business were structured as a pass-through entity. Businesses should work closely with their tax and legal advisors to continuously evaluate choice-of-entity considerations.

Bonus Depreciation

Under the TCJA, businesses are allowed an immediate first-year deduction of 100% of the cost of new or used qualified property purchased and placed into service after September 27, 2017 and before January 01, 2023. Qualified property generally includes tangible personal property with a recovery period of 20 years or less. Qualified property includes qualified leasehold improvements. The allowance of bonus depreciation for used property only applies where the taxpayer has not used the property prior to acquiring it. The expansion of bonus depreciation to used property offers a drastic benefit to taxpayers acquiring existing businesses.

In an asset acquisition, buyers are now eligible to claim 100% bonus depreciation on the tangible personal property of the business, rather than depreciating it over five or seven years. Businesses contemplating purchasing equipment (whether new or used) should consider doing so prior to 2023 to take advantage of immediate expensing under the TCJA.

Work Opportunity Tax Credit

Business owners should also consider taking advantage of the Work Opportunity Tax Credit, which offers federal tax credits up to $9,600 per employee hired if the employee hired is from a certain targeted group. This group includes unemployed and disabled veterans, food stamp recipients, TANF recipients, ex-felons, and other groups who are traditionally at a hiring disadvantage.

With the Work Opportunity Tax Credit, private, for-profit employers can earn a tax credit ranging from $2,400 to $9,600 per employee hired. Generally, the credit is 40% of qualified wages paid to individuals who work 400 hours or more in their first year of employment. This is a one-time tax credit for each new employee hired and there is no limit on the number of newly hired employees who can qualify an employer for the tax credit.

SALT Cap Workaround for Pass-Through Entities

Many states have begun allowing owners of pass-through entities to pay their state and local taxes at the business entity level rather than individually. In a state where legislation has been enacted, pass-through entities generally make an election to pay an income tax, which can be taken as a tax credit on the owner’s individual tax return. This trend is an attempt to create a workaround to the current federal limitation of $10,000 for individual taxpayer deductions on state and local taxes. In most states with a SALT cap workaround, this is not automatic, and the pass-through entity will need to make an election by a set deadline.

Business owners should regularly discuss tax planning strategies with their tax advisors to determine whether there are additional opportunities for savings.

*This article originally appeared in the April 2022 issue of Corp! Magazine.