Blake E. Christian
Blake E. Christian

C corporations back in vogue?

Closely held business owners will be taking a second look.

November 29, 2012
By Blake E. Christian, CPA

Absent a softening in President Barack Obama’s “line in the sand” regarding a threatened veto for any extension of the Bush-era tax cuts for taxpayers making more than $250,000, higher-income taxpayers, including those operating through S corporations, LLCs, and other passthrough entities, can expect higher tax rates in 2013 and beyond as a result of the Health Care and Education Reconciliation Act, P.L. 111-152 (one of the major components of health reform), and other expiring tax rates, credits, and deductions.

As a result, business owners and their CPAs should take a second look at operating all or some of their activities through existing or newly established C corporations to lower overall effective tax rates.

As of the date of this article, starting with calendar years ending on or after Dec. 31, 2012, federal income tax rates for individuals were set to rise as high as 43.4% (for investment or passive income) for joint filing taxpayers making more than $250,000. In some rare cases, individual taxpayers have elected fiscal year ends, and they will be grandfathered under the current rate structure for tax years beginning before Dec. 31, 2012. The rise in individual and trust rates for 2013 is detailed below:

Current law
(expiring 12/31/12)

New law
(effective 1/1/13)

Maximum tax rate on ordinary income*



Additional Medicare tax on net investment income



Total: Maximum rate on investment income






Net percentage increase in rates (2013 vs. 2012)



*Wage and self-employment income over certain thresholds (e.g., $250,000 for married taxpayers filing jointly) will be subject to an additional 0.9% Medicare tax after 2012.

For a more detailed discussion of scheduled rate increases, see Christian, “2013 Tax Changes Require Thorough Year-End Tax Planning,” Corporate Taxation Insider (Aug. 23, 2012).

The current tax rates for C corporations (other than personal service corporations under Sec. 11, which are taxed at the maximum individual rates) are summarized below:

Taxable Income

Tax Rate

$0 to $50,000


More than $50,000 to $75,000


More than $75,000 to $10,000,000


More than $10,000,000


*A 39% rate applies on income over $100,000 and up to $335,000, which results in a phaseout of the graduated rate for C corporations on their income up to $100,000.

Thus, the tax on the first $100,000 of C corporation income would be as follows:

Taxable income

Tax rate

Tax imposed

First $50,000



Next $25,000



Next $25,000



First $100,000 taxable
income, effective tax rate






Next $150,000



First $250,000 taxable
income, effective tax rate



Therefore, post-2012, there will generally be a beneficial rate differential of 21.15% (43.4% – 22.25%) on the first $100,000 of C corporation earnings shifted from an individual in the maximum tax bracket; and 11.1% (43.4% – 32.3%) for taxpayers with $250,000 of taxable income operating as a C corporation.

Of course, C corporations have not been the entity of choice for CPAs and closely held business owners for the past couple of decades for a number of reasons:

  • Double taxation—once at the entity level, then again on dividend distributions.
  • Tax inefficiency upon disposition structured as an asset sale. If a non-Sec. 338 stock sale can be negotiated by the seller, the tax inefficiency can be mitigated.
  • Potential exposure to accumulated earnings tax under Sec. 531.
  • Potential personal service corporation status if the majority of income is earned income, which would subject all of the corporation’s income to the highest corporate rate.

While the above disadvantages are still present, post-2013 annual tax savings associated with operating income retained in a C corporation can offer significant advantages, and future wages and/or dividend distributions can be timed for overall tax efficiency.

Some of the other advantages for layering a C corporation entity into business operations:

  • Limited liability for shareholders, consistent with S corporations, LLCs, and certain partnerships.
  • No restrictions on type of owners, as there are for S corporations.
  • Different classes of ownership permitted.
  • Shareholders/employees may participate in employee benefit/retirement programs, and compensation can be reported on Form W-2, Wage and Tax Statement. Members of LLCs and partners in partnerships cannot be treated as employees.

In layering a C corporation into a business owner’s overall tax planning, care must be exercised in moving existing operations into the C corporation, and “arms-length” financial structuring under Sec. 482 must be fully evaluated to avoid the IRS’s attempting to reallocate items differently than the business has treated them.

New business operations are ideal for this strategy, and consideration should be given to bifurcating general manufacturing, sales, etc., from intellectual property, R&D, etc. (the assets of which may be best in a flowthrough entity for tax efficiency on a future sale).

With the probable increase in individual tax rates, the use of C corporations for a portion of business operations should be reconsidered in the overall tax planning process.

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Blake E. Christian, CPA, is a tax partner in the Long Beach, Calif., office of Holthouse, Carlin & Van Trigt LLP.