Pass-Through Versus C Corporation . Twelve years ago, your
client formed a C corporation with a $100,000 investment (contribution). The
corporation’s BTROR (Re) has been and will continue to be 10%. The corporate
tax rare (re) has been 35% for the last 12 years, but because of a tax law
change, the corporation’s tax rate will be 21 % for the foreseeable future. The
corporation pays no dividends and reinvests all after-tax earnings in its
business. Thus, the corporation’s value grows at its ATROR. Your client’s
marginal ordinary tax rare (tp) has been 33%, and her capital gains rate has
been 15%. Because of the same tax law cliange, your client’s ordinary tax rare
dropped to 24% at the beginning of this year and will stay at that level
indefinitely. Her capita l gains tax rate will remain at 15%. Assume the
corporate stock does not qualify for the Sec. 1202 exclusion for gain on the
sale of small business stock. Your client wants you to consider three
alternatives:
1. Continue the business in C corporation form for the next
20 years and liquidate at that time (32 years in total).
2. Liquidate the C corporation at the end of the 12-year
period, invest the after-tax proceeds in a sole proprietorship, and operate as
a sole proprietorship for the next 20 years. Your client will claim the 20% QBI
deduction in the sole proprietorship case.
3. Make an S corporation election effective at the beginning
of this year, operate as an S corporation for the next 20 years, and liquidate
the S corporation at that time (32 years in coral). Your client will claim the
20% QBI deduction in the S corporation case.
Regarding Alternatives 2 and 3, the sole proprietorship ‘s
or S corporation’s BTROR (Rp) also will be 10% for the next 20 years. Earnings
from the sole proprietorship or S corporation will be taxed currently at your
client’s ordinary tax rate (adjusted for the QBI deduction percentage), and
your client will withdraw just enough from the business to pay her taxes. The
remaining after-tax earnings will remain in the business until the end of the investment
horizon (20 years from now ). Show the results of each alternative along with
supporting models and calculations. Which alternative should your client adopt?
Ignore the accumulated earnings tax for C corporations.
Leave a Reply