By Matthew A. Brown, CPA; Natalie A. Frenier, CPA; and Joseph A. Magyar, CPA
At the end of 2017, President Donald Trump signed into law some of the most comprehensive tax changes enacted in decades, known as the Tax Cuts and Jobs Act. With the law’s special focus on the taxation of businesses, it’s important for auto dealers to understand the changes and potential implications.
This column looks at the implications of the C-corp structure under the new tax laws. It is the first in a series of articles highlighting areas for dealers to note so they can take advantage of the new laws.
Evaluating the use of C Corporations
One of the most significant features of the tax overhaul is the reduction of corporate tax rates from a top marginal rate of 35 percent to a flat rate of 21 percent, starting in 2018. In addition, the corporate alternative minimum tax has been repealed. Both changes represent significant potential savings for businesses structured as C corporations.
However, most dealerships today are not structured as C-corps. Rather, the majority are pass-through businesses, such as S corporations, or entities that are taxed as partnerships, such as limited liability companies. With the lower tax rates available for C-corps, it’s reasonable to assume that the changes may result in auto dealers making greater use of C-corps.
Those dealers not currently structured as C-corps may want to review their options with their tax advisers and conduct a thorough analysis in this area. Businesses would have needed to decide by mid-March 2018 if they want to convert retroactively from a pass-through entity to a C-corp effective for all of 2018. Generally, they can make the conversion on a prospective basis at any time.
When carefully weighing the benefits and disadvantages of moving from a pass-through business to a C-corp, dealers may want to consider the following areas:
- Intent to distribute profits. If the business does not plan to distribute dividends, then, at the federal level, it may, as a C-corp, have a tax rate advantage. After converting to a C-corp, the corporation may, for a limited time, distribute, tax free, the previously taxed but not distributed S-corporation profits. However, if the business will be distributing 100 percent of profits every year, there will be a federal tax rate advantage to being structured as an S corporation after taking into consideration the double tax of C-corporation dividends.
- Potential future sale of the business. For sales involving an S corporation, the gain from the sale of blue sky or goodwill assets might qualify for long-term capital gain treatment. These gains still will be taxed at the 20 percent capital gain rate. That is not much different from the 21 percent C-corporation tax rate. The S-corporation structure, however, would avoid the double layer of tax when, after the sale, the proceeds are distributed in a liquidation of the C corporation.
- State tax implications. The loss of state income tax deductions may have a potentially significant negative effect on some pass-through owners, but corporations may deduct state taxes.
- Ability to retain current accounting methods (or adopt new methods). If a business converts from an S corporation to a C corporation, it generally would retain its accounting methods. However, if it coverts from a partnership to a C-corp, the business generally will have the opportunity to establish new accounting methods.
When converting from a partnership or an S-corp to a C-corp, there generally is no last-in, first-out (LIFO) recapture tax. However, if the business later converts back to an S-corp (which typically can be done only after five years), the business would be required to pay LIFO recapture tax at that time on all prior LIFO deferrals. This is an important area to consider, especially if the business does not believe the current tax reforms have staying power.
- Interaction with other business interests such as real estate and management companies. It’s possible entities such as these might not qualify for the pass-through deduction and could even be taxed as high as 37 percent. Therefore, dealers may want to consider converting a management company or real estate entity to a C-corp while the dealership remains a pass-through entity.
Crowe Horwath is a global public accounting, technology, and consulting firm. Joe Magyar is a partner with Crowe Horwath and can be reached at 1-813 209 2435 or email@example.com. Matthew Brown can be reached at 1-954-202-8535 or firstname.lastname@example.org. Natalie Frenier can be reached at 1-614-469-1279 or email@example.com.