Are you planning to launch a business or thinking about changing your business entity? If so, you need to determine which entity will work best for you — a C corporation or a pass-through entity such as a sole-proprietorship, partnership, limited liability company (LLC) or S corporation. There are many factors to consider and proposed federal tax law changes being considered by Congress may affect your decision.

The corporate federal income tax is currently imposed at a flat 21% rate, while the current individual federal income tax rates begin at 10% and go up to 37%. The difference in rates can be mitigated by the qualified business income (QBI) deduction that’s available to eligible pass-through entity owners that are individuals, estates and trusts.

Note that noncorporate taxpayers with modified adjusted gross income above certain levels are subject to an additional 3.8% tax on net investment income.

Organizing a business as a C corporation instead of as a pass-through entity can reduce the current federal income tax on the business’s income. The corporation can still pay reasonable compensation to the shareholders and pay interest on loans from the shareholders. That income will be taxed at higher individual rates, but the overall rate on the corporation’s income can be lower than if the business was operated as a pass-through entity.

Other considerations

Other tax-related factors should also be considered. For example:

• If substantially all the business profits will be distributed to the owners, it may be preferable that the business be operated as a pass-through entity rather than as a C corporation, since the shareholders will be taxed on dividend distributions from the corporation (double taxation). In contrast, owners of a pass-through entity will only be taxed once, at the personal level, on business income. However, the impact of double taxation must be evaluated based on projected income levels for both the business and its owners.
• If the value of the business’s assets is likely to appreciate, it’s generally preferable to conduct it as a pass-through entity to avoid a corporate tax if the assets are sold or the business is liquidated. Although corporate level tax will be avoided if the corporation’s shares, rather than its assets, are sold, the buyer may insist on a lower price because the tax basis of appreciated business assets cannot be stepped up to reflect the purchase price. That can result in much lower post-purchase depreciation and amortization deductions for the buyer.
• If the entity is a pass-through entity, the owners’ bases in their interests in the entity are stepped-up by the entity income that’s allocated to them. That can result in less taxable gain for the owners when their interests in the entity are sold.
• If the business is expected to incur tax losses for a while, consideration should be given to structuring it as a pass-through entity so the owners can deduct the losses against their other income. Conversely, if the owners of the business have insufficient other income or the losses aren’t usable (for example, because they’re limited by the passive loss rules), it may be preferable for the business to be a C corporation, since it’ll be able to offset future income with the losses.
• If the owners of the business are subject to the alternative minimum tax (AMT), it may be preferable to organize as a C corporation, since corporations aren’t subject to the AMT. Affected individuals are subject to the AMT at 26% or 28% rates. 

These are only some of the many factors involved in operating a business as a certain type of legal entity. For details about how to proceed in your situation, consult with us.

© 2021

With the increasing cost of employee health care benefits, your business may be interested in providing some of these benefits through an employer-sponsored Health Savings Account (HSA). For eligible individuals, an HSA offers a tax-advantaged way to set aside funds (or have their employers do so) to meet future medical needs. Here are the important tax benefits:

• Contributions that participants make to an HSA are deductible, within limits.
• Contributions that employers make aren’t taxed to participants.
• Earnings on the funds in an HSA aren’t taxed, so the money can accumulate tax free year after year.
• Distributions from HSAs to cover qualified medical expenses aren’t taxed.
• Employers don’t have to pay payroll taxes on HSA contributions made by employees through payroll deductions.

Eligibility rules

To be eligible for an HSA, an individual must be covered by a “high deductible health plan.” For 2021, a “high deductible health plan” is one with an annual deductible of at least $1,400 for self-only coverage, or at least $2,800 for family coverage. (These amounts will remain the same for 2022.) For self-only coverage, the 2021 limit on deductible contributions is $3,600 (increasing to $3,650 for 2022). For family coverage, the 2021 limit on deductible contributions is $7,200 (increasing to $7,300 for 2022). Additionally, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits for 2021 cannot exceed $7,000 for self-only coverage or $14,000 for family coverage (increasing to $7,050 and $14,100, respectively, for 2022).

An individual (and the individual’s covered spouse, as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional “catch-up” contributions for 2021 and 2022 of up to $1,000.

Contributions from an employer

If an employer contributes to the HSA of an eligible individual, the employer’s contribution is treated as employer-provided coverage for medical expenses under an accident or health plan. It’s also excludable from an employee’s gross income up to the deduction limitation. Funds can be built up for years because there’s no “use-it-or-lose-it” provision. An employer that decides to make contributions on its employees’ behalf must generally make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer doesn’t make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.

Taking distributions

HSA distributions can be made to pay for qualified medical expenses, which generally means expenses that would qualify for the medical expense itemized deduction. Among these expenses are doctors’ visits, prescriptions, chiropractic care and premiums for long-term care insurance.

If funds are withdrawn from the HSA for other reasons, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it’s made after reaching age 65, or in the event of death or disability.

HSAs offer a flexible option for providing health care coverage and they may be an attractive benefit for your business. But the rules are somewhat complex. Contact us if you’d like to discuss offering HSAs to your employees.

© 2021