Corporate structure plays a major role in determining tax paid on federal and state returns, both annually and over the lifetime of a company. Luckily, you can modify your structure as needed to minimize liabilities or serve other corporate or personal goals. However, many organizations fail to consider their options and incur tax liabilities they could have avoided.
Benefits for Cooperatives
Cooperatives enjoy a patronage exclusion that allows them to eliminate margins from business conducted with members from their taxable earnings. Co-ops were granted this tax break years ago in the interest of promoting universal (wired) telephone service. They’ve since branched out into non-traditional services (e.g., wireless, cable TV), often by creating wholly-owned subsidiaries.
However, these subsidiaries may not need to be structured that way. By folding operations into the parent company, the combined entity could reap tax savings on the portion of non-traditional services delivered to members.
Beyond the obvious tax savings, the adjustment in corporate structure could sweeten the appeal of the company’s bundled product offerings. After all, the more the company earns on its bottom line, the more capital credits would be distributed to members based on their patronage.
Benefits for Investor-Owned Companies
The stock for investor-owned companies may be closely held by owner-operators. As such, the optimal corporate structure considers the company’s tax liabilities as well as those of its owners.
If currently structured as a C corporation, the company might benefit from a transition to an S corporation. Income from a C corporation gets taxed twice before landing in the shareholders’ hands. Corporate tax rates apply to the company’s net income, and individual tax rates apply to each individual’s corporate dividends. By contrast, income from an S corporation only gets taxed once on each shareholder’s tax return. S corporations may deliver favorable tax treatment by leveraging cash accounting instead of accrual accounting. Also, sales of appreciated assets can create significant tax implications when the gain is locked inside a C corporation.
On the other hand, when key employees prove crucial to the health and long-term viability of the company, owner-operators may opt to grant stock options to motivate performance excellence and instill loyalty. A C corp is a natural structure for this arrangement. The bottom line results associated with having the right people in the right jobs may outweigh the potential tax savings of transitioning to an S corp.
If the majority shareholders are nearing retirement, they may want to liquidate holdings to fund their golden years. Based on how long they’ve owned their stock and the means through which it was acquired, it may be helpful for them to maintain the C corp status until they no longer have an interest in the company.
Owner-operators may also wish to consider the impact of the corporate structure on their estate plans. Some may wish to find a tax-efficient way to transfer ownership to their heirs. Others may have complex designs for the disposition of their residual estate.
At the end of the day, the decision comes down to a spirited discussion of the company and owner’s current positions and future plans. The sooner decisions are made, the easier it will be to adjust the corporate structure and take advantage of tax savings.
Our tax specialists can help you determine the optimal corporate structure for your company, whether you anticipate any near-term change in your ownership structure or senior leadership or not. Our experience over the past five years suggests strategic adjustments in corporate structure can result in annual savings of up to 25 percent. Keep in mind, benefits typically apply to future periods. You can’t make a conversion in January and expect favorable treatment for the prior calendar year.
As noted earlier, companies often run on auto-pilot when it comes to their corporate structure. Company goals change. Personal goals and circumstances change. Tax legislation changes.
It’s a good idea to consider your options periodically to ensure you’re on the right course. With an appropriate lead time, you have the best chance of minimizing your tax liability and retaining your hard-earned cash.
Meet the Author
Partner, Communications and Utilities
Ryan Johnson, CPA
Aldrich CPAs + Advisors LLP
Ryan Johnson is an expert on the taxation of communications and power companies. He specializes in both business and individual taxation and has significant experience consulting on the structure of entities and transactions, including mergers and acquisitions. Ryan is passionate about keeping his telecommunications and utility clients informed about taxation matters relevant to their industries…
- Business sales and purchases
- Certified Public Accountant