Business Finance Homework Help

For this week’s discussion, choose 1 of the following topics and post your initial response in the Discussion Board.

1. The Tax Cuts and Jobs Act of 2017 changed the C Corporation tax rate to 21%. Many believe that if the business owner’s marginal tax rate is higher than the corporate rate the owner should reorganize their business as a C corporation. How would you respond?
2. International Financial Reporting Standards, a widely used set of accounting principles, does not allow the use of the LIFO inventory costing method. Explain the reasons for disallowing this method and discuss the tax impacts a change from LIFO to FIFO would have on a business.
3. S Corporation owners have attempted to avoid employment taxes by distributing earnings instead of making payments through payroll. Discuss how the IRS has attempted to mitigate this and the issue accountants may face with regards to what is considered reasonable compensation for services.

Do the discussion and response each posted down below

Posted 1

Generally, one would believe if the business owner’s marginal tax rate is higher than the corporate rate, the owner should reorganize their entity as a C corporation. This wouldn’t be considered tax planning opportunity in years past, as the corporate tax rate was 35%. The highest individual tax rate was around 37%. Additionally, C corporation profits are subject to double taxation. The corporation pays an entity level tax on profits, and a shareholder pays tax on the dividends (the distribution of corporate earnings) he receives. Additionally, a shareholder is not allowed to take any of the C corporation losses on his individual return.

The double taxation issue is a tough hurdle to get around when thinking about reorganizing a business entity to a C corporation. As such, tax savings are not the only item to consider. One must also consider the strategic direction of the company. Will the company want to raise a bunch of capital to expand, or will it want to become a publicly traded company one day? Becoming a C corporation may make sense. Is business continuity and succession planning a concern? Some entities cease to exist when an owner leaves the business or dies; this is not the case with C corporations. There are other taxes that may be a consideration – is the additional investment income tax a concern or AMT or self-employment tax? Will the owner benefit from the qualified business income deductions which will reduce his or her marginal rate so that any tax savings from reorganization are nil?

Does the owner plan to distribute earnings or retain them in the business? The double taxation issue may be mitigated in this instance. How much will it cost to reorganize? What will be the effect of state taxes if the entity reorganizes? In other words, my answer would be “it depends”. There are many factors one would need to consider with respect to this question and not just the tax rate.

References

Everett, J., Hennig, C., & Nichols, N. (2016). Contemporary Tax Practice: Research, Planning and Strategies. CCH® Publications.

Posted 2

When looking at the tax rates of a C Corporation versus a Sole Proprietorship at a high level one would think this decision is very easy. The rate for a C Corporation after the Tax Cuts and Jobs Act of 2017 is 21 percent while the max effective tax rate for a Sole Proprietorship is 29.6 percent (Tarkenton Institute Inc, 2019). With this information, should every Sole Proprietorship business should switch to a C corporation?

Not so fast, currently a very profitable business currently structured as a Sole Proprietorship would pass its profit to the owner’s income tax return at an effective tax ratee of 29.6 percent with the qualified business income deduction added with the TCJA (Tarkenton Institute Inc, 2019). The deduction is allowed on income up to $415,000 (Tarkenton Institute Inc, 2019). If the business owner restructured the business as a C corporation, the taxes due on the profit would be 21% and then the owner would have to pay taxes on payout from the C corporation (Tax Policy Center, n.d.). The effective rate on profits would be maxed at 29.6 percent if left as a Sole Proprietorship and the earnings would be double taxed if placed in a C corporation which would lead to a effective tax rate significantly higher than 29.6 percent.

In conclusion, I would advise a business owner to leave the business structure as a Sole Proprietorship, if the business is operating with a sizeable profit. The effective taxes paid would be lower for the current structure than moving the business to a C corporation. By moving to a C corporation, the owner would create a double taxation situation when dividends are paid out to the owner(s) of the corporation. On the other hand, if the business is reinvesting all its profits and not dispersing income, then the owner may want to consider moving to a C corporation since there would be no disbursement of income to owners.

Works Cited

Tarkenton Institute Inc. (2019, March 15). Rethinking Your Business Entity Choice in Light of the TCJA. Retrieved from SmallBIzClub: https://smallbizclub.com/startup/making-your-busin…

Tax Policy Center. (n.d.). How did the Tax Cuts and Jobs Act change business taxes? Retrieved from Tax Policy Cetner: https://www.taxpolicycenter.org/briefing-book/how-…