Nearly six months after the federal tax law changes passed in late December, accountants are making recommendations to their business clients about strategies they should consider for their 2018 filings.
Those include dealing with changes in amount of interest deductions allowed, something that could have implications for wine industry, and certain tax implications based on which revenue accounting method to use.
But Ray Pounds of Pisenti & Brinker, a 50-person firm with offices in Santa Rosa, Petaluma and Napa, said, “Probably the most significant change that has not been a factor in some time is choice of entity.”
The choice Pounds means is between being a C corporation or an S corporation under U.S. tax law.
For-profit businesses are automatically incorporated as C corporations, which pay corporate taxes, but they can, if they meet certain ownership rules, elect to become S corporations, which pass profit or loss through to their shareholders, who then pay individual taxes. Shareholders of C corporations are thus “taxed twice” in a sense.
For many years, Pound said, the difference between corporate and individual tax rates made S corporation registration attractive, depending on the type of business.
When tax changes in the 1980s lowered the individual tax rate and increased the spread between personal and corporate rates, his customers began looking at S corporation registration with more interest.
“When the corporate tax rate was 34 or 35 percent and the individual rate dropped to 28 percent, people said, ‘Now’s the time to think about going to an S corporation,’” said Pounds, who started work as an accountant in 1972, as soon as he graduated from University of California, Berkeley. “Everybody raced to the IRS to change — those who could qualify.”
But the changes coming for 2018 turn that historical situation on its head, he said. “The C corporation rate is 21 percent — that’s a free fall from 34 or 35. Now you’ve got the reverse where individual rates are higher.”
Caveat C corp.
But though the drop to a flat 21 percent tax rate for C corporations might make some business owners consider changing, most accountants still counsel caution.
“Don’t do anything drastic,” said Buddy Wall, a tax partner at Moss Adams, who works in the firm’s Fountain Grove office in Santa Rosa.
Although changing from an S corporation to a C corporation isn’t at all difficult, there are complex ramifications that aren’t easy to predict. And switching back to an S corporation again isn’t possible for five years.
“The problem is that if you elect to become a C corp., you’ve got to wait five years,” said Wall. “You’ve really got to run the numbers by your CPA. Are you going to sell the company? If you are, it’s better to stay an S corp.”
Different types of businesses also have different needs that are better met by being one type of corporation or the other, Wall said. Many of his clients, for example, are in the construction industry, and have different cash needs than, say, someone in retail or agriculture. A flow-through S corporation model fits them better.
“When it comes down to it, I’m still a flow-through guy,” Wall said. “Most of my closely held clients take money out of the business above their taxes. For construction, I don’t see anybody switching over to C corp. They’re going to pay less tax with the flow through. It’s still beneficial to be an S corp. and an LLC.”
“If you have a lot of debt on your books and you’re going to try to deduct interest, that’s going to be lowered.”
—Buddy Wall, tax partner at Moss Adams
“Because it’s so capital intensive, some of our startup wineries have borrowed quite a bit of money. They were deducting 100 percent of the interest expense and had very little income.”
—Jim Caven, specializing in wine at Pisenti & Brinker’s Napa office