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Choosing the right business entity is a key decision for any business. The entity you pick can affect your tax bill, your personal liability and other issues. For many businesses, a limited liability company (LLC) is an attractive choice. It can be structured to resemble a corporation for owner liability purposes and a partnership for federal tax purposes. This duality may provide the owners with several benefits.

Like the shareholders of a corporation, the owners of an LLC (called members rather than shareholders or partners) generally aren’t liable for business debts except to the extent of their investment. Therefore, an owner can operate a business with the security of knowing that personal assets (such as a home or individual investment account) are protected from the entity’s creditors. This protection is far greater than that afforded by partnerships. In a partnership, the general partners are personally liable for the debts of the business. Even limited partners, if they actively participate in managing the business, can have personal liability.

Electing classification

LLC owners can elect, under the “check-the-box rules,” to have the entity treated as a partnership for federal tax purposes. This can provide crucial benefits to the owners. For example, partnership earnings aren’t subject to an entity-level tax. Instead, they “flow through” to the owners in proportion to the owners’ respective interests in the profits and are reported on the owners’ individual returns and taxed only once. To the extent the income passed through to you is qualified business income (QBI), you’ll be eligible to take the QBI deduction, subject to various limitations.

In addition, since you’re actively managing the business, you can deduct on your individual tax return your ratable shares of any losses the business generates. This, in effect, allows you to shelter other income that you (and your spouse, if you’re married) may have.

An LLC that’s taxable as a partnership can provide special allocations of tax benefits to specific partners. This can be an important reason for using an LLC over an S corporation (a form of business that provides tax treatment that’s similar to a partnership). Another reason for using an LLC over an S corporation is that LLCs aren’t subject to the restrictions the federal tax code imposes on S corporations regarding the number of owners and the types of ownership interests that may be issued. (For example, an S corp can’t have more than 100 shareholders and can only have one class of stock.)

Evaluate the options

To sum up, an LLC can give you protection from creditors while providing the benefits of taxation as a partnership. Be aware that the LLC structure is allowed by state statute, and states may use different regulations. Contact us to discuss in more detail how use of an LLC or another option might benefit you and the other owners.

Partnerships are often used for business and investment activities. So are multi-member LLCs that are treated as partnerships for tax purposes. A major reason is that these entities offer federal income tax advantages, the most important of which is pass-through taxation. They also must follow some special and sometimes complicated federal income tax rules.

Governing documents

A partnership is governed by a partnership agreement, which specifies the rights and obligations of the entity and its partners. Similarly, an LLC is governed by an operating agreement, which specifies the rights and obligations of the entity and its members. These governing documents should address certain tax-related issues. Here are some key points when creating partnership and LLC governing documents.

Partnership tax basics

The tax numbers of a partnership are allocated to the partners. The entity issues an annual Schedule K-1 to each partner to report his or her share of the partnership’s tax numbers for the year. The partnership itself doesn’t pay federal income tax. This arrangement is called pass-through taxation, because the tax numbers from the partnership’s operations are passed through to the partners who then take them into account on their own tax returns (Form 1040 for individual partners).

Partners can deduct partnership losses passed through to them, subject to various federal income tax limitations such as the passive loss rules.

Special tax allocations

Partnerships are allowed to make special tax allocations. This is an allocation of partnership loss, deduction, income or gain among the partners that’s disproportionate to the partners’ overall ownership interests. The best measure of a partner’s overall ownership interest is the partner’s stated interest in the entity’s distributions and capital, as specified in the partnership agreement. An example of a special tax allocation is when a 50% high-tax-bracket partner is allocated 80% of the partnership’s depreciation deductions while the 50% low-tax-bracket partner is allocated only 20% of the depreciation deductions.

Any special tax allocations should be set forth in the partnership agreement. However, to make valid special tax allocations, you must comply with complicated rules in IRS regulations.

Distributions to pay partnership-related tax bills

Partners must recognize taxable income for their allocations of partnership income and gains — whether those income and gains are distributed as cash to the partners or not. Therefore, a common partnership agreement provision is one that calls for the partnership to make cash distributions to help partners cover their partnership-related tax liabilities. Of course, those liabilities will vary, depending on the partners’ specific tax circumstances. The partnership agreement should specify the protocols that will be used to calculate distributions intended to help cover partnership-related tax bills.

For instance, the protocol for long-term capital gains might call for distributions equal to 15% or 20% of each partner’s allocation of the gains.

Such distributions may be paid out in early April of each year to help cover partners’ tax liabilities from their allocations of income and gains from the previous year.

Contact us for assistance

When putting together a partnership or LLC deal, tax issues should be addressed in the agreement. Contact us to be involved in the process.

Let’s say you own real estate that has been held for more than one year and is sold for a taxable gain. Perhaps this gain comes from indirect ownership of real estate via a pass-through entity such as an LLC, partnership or S corporation. You may expect to pay Uncle Sam the standard 15% or 20% federal income tax rate that usually applies to long-term capital gains from assets held for more than one year.

However, some real estate gains can be taxed at higher rates due to depreciation deductions. Here’s a rundown of the federal income tax issues that might be involved in real estate gains.

Vacant land

The current maximum federal long-term capital gain tax rate for a sale of vacant land is 20%. The 20% rate only hits those with high incomes. Specifically, if you’re a single filer in 2024, the 20% rate kicks in when your taxable income, including any land sale gain and any other long-term capital gains, exceeds $518,900. For a married joint-filing couple, the 20% rate kicks in when taxable income exceeds $583,750. For a head of household, the 20% rate kicks when your taxable income exceeds $551,350. If your income is below the applicable threshold, you won’t owe more than 15% federal tax on a land sale gain. However, you may also owe the 3.8% net investment income tax (NIIT) on some or all of the gain.

Gains from depreciation

Gain attributable to real estate depreciation calculated using the applicable straight-line method is called unrecaptured Section 1250 gain. This category of gain generally is taxed at a flat 25% federal rate, unless the gain would be taxed at a lower rate if it was simply included in your taxable income with no special treatment. You may also owe the 3.8% NIIT on some or all of the unrecaptured Section 1250 gain.

Gains from depreciable qualified improvement property

Qualified improvement property (QIP) generally means any improvement to an interior portion of a nonresidential building that’s placed in service after the date the building is placed in service. However, QIP does not include expenditures for the enlargement of the building, elevators, escalators or the building’s internal structural framework.

You can claim first-year Section 179 deductions or first-year bonus depreciation for QIP. When you sell QIP for which first-year Section 179 deductions have been claimed, gain up to the amount of the Section 179 deductions will be high-taxed Section 1245 ordinary income recapture. In other words, the gain will be taxed at your regular rate rather than at lower long-term gain rates. You may also owe the 3.8% NIIT on some or all of the Section 1245 recapture gain.

What if you sell QIP for which first-year bonus depreciation has been claimed? In this case, gain up to the excess of the bonus depreciation deduction over depreciation calculated using the applicable straight-line method will be high-taxed Section 1250 ordinary income recapture. Once again, the gain will be taxed at your regular rate rather than at lower long-term gain rates, and you may also owe the 3.8% NIIT on some or all of the recapture gain.

Tax planning point: If you opt for straight-line depreciation for real property, including QIP (in other words, you don’t claim first-year Section 179 or first-year bonus depreciation deductions), there won’t be any Section 1245 ordinary income recapture. There also won’t be any Section 1250 ordinary income recapture. Instead, you’ll only have unrecaptured Section 1250 gain from the depreciation, and that gain will be taxed at a federal rate of no more than 25%. However, you may also owe the 3.8% NIIT on all or part of the gain.

Plenty to consider

As you can see, the federal income tax rules for gains from sales of real estate may be more complicated than you thought. Different tax rates can apply to different categories of gain. And you may also owe the 3.8% NIIT and possibly state income tax, too. We will handle the details when we prepare your tax return. Contact us with questions about your situation.

Get ready: The upcoming presidential and congressional elections may significantly alter the tax landscape for businesses in the United States. The reason has to do with a tax law that’s scheduled to expire in about 17 months and how politicians in Washington would like to handle it.

How we got here

The Tax Cuts and Jobs Act (TCJA), which generally took effect in 2018, made extensive changes to small business taxes. Many of its provisions are set to expire on December 31, 2025.

As we get closer to the law sunsetting, you may be concerned about the future federal tax bill of your business. The impact isn’t clear because the Democrats and Republicans have different views about how to approach the various provisions in the TCJA.

Corporate and pass-through business rates

The TCJA cut the maximum corporate tax rate from 35% to 21%. It also lowered rates for individual taxpayers involved in noncorporate pass-through entities, including S corporations and partnerships, as well as from sole proprietorships. The highest rate today is 37%, down from 39.6% before the TCJA became effective.

But while the individual rate cuts expire in 2025, the law made the corporate tax cut “permanent.” (In other words, there’s no scheduled expiration date. However, tax legislation could still raise or lower the corporate tax rate.)

In addition to lowering rates, the TCJA affects tax law in many other ways. For small business owners, one of the most significant changes is the potential expiration of the Section 199A qualified business income (QBI) deduction. This is the write-off for up to 20% of QBI from noncorporate entities.

Another of the expiring TCJA business provisions is the gradual phaseout of first-year bonus depreciation. Under the TCJA,100% bonus depreciation was available for qualified new and used property that was placed in service in calendar year 2022. It was reduced to 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026 and 0% in 2027.

Potential Outcomes

The outcome of the presidential election in three months, as well as the balance of power in Congress, will determine the TCJA’s future. Here are four potential outcomes:

All of the TCJA provisions scheduled to expire will actually expire at the end of 2025.
All of the TCJA provisions scheduled to expire will be extended past 2025 (or made permanent).
Some TCJA provisions will be allowed to expire, while others will be extended (or made permanent).
Some or all of the temporary TCJA provisions will expire — and new laws will be enacted that provide different tax breaks and/or different tax rates.

How your tax bill will be affected in 2026 will partially depend on which one of these outcomes actually happens and whether your tax bill went down or up when the TCJA became effective years ago. That was based on a number of factors including your business income, your filing status, where you live (the SALT limitation negatively affects taxpayers in certain states), and whether you have children or other dependents.

Your tax situation will also be affected by who wins the presidential election and who controls Congress because Democrats and Republicans have competing visions about how to proceed. Keep in mind that tax proposals can become law only if tax legislation passes both houses of Congress and is signed by the President (or there are enough votes in Congress to override a presidential veto).

Look to the future

As the TCJA provisions get closer to expiring, and the election gets settled, it’s important to know what might change and what tax-wise moves you can make if the law does change. We can answer any questions you have and you can count on us to keep you informed about the latest news.__

While many facets of the economy have improved this year, the rising cost of living and other economic factors have caused many businesses to close their doors. If this is your situation, we can help you, including taking care of various tax responsibilities.

To start with, a business must file a final federal income tax return and some other related forms for the year it closes its doors. The type of return that must be filed depends on the type of business you have. For example:

Sole Proprietors will need to file the usual Schedule C, “Profit or Loss from Business,” with their individual returns for the year they close their businesses. They may also need to report self-employment tax.
Partnerships must file Form 1065, “U.S. Return of Partnership Income,” for the year they close. They also must report capital gains and losses on Schedule D. They indicate that this is the final return and do the same on Schedule K-1, “Partner’s Share of Income, Deductions, Credits, etc.”
All Corporations need to file Form 966, “Corporate Dissolution or Liquidation,” if they adopt a resolution or plan to dissolve an entity or liquidate any of its stock.
C Corporations must file Form 1120, “U.S. Corporate Income Tax Return,” for the year they close. They report capital gains and losses on Schedule D and indicate this is the final return.
S Corporations need to file Form 1120-S, “U.S. Income Tax Return for an S Corporation,” for the year of closing. They report capital gains and losses on Schedule D. The “final return” box must be checked on Schedule K-1.
All Businesses may need to be filed other tax forms to report sales of business property and asset acquisitions if they sell the business.

Tying up loose ends with workers

If you have employees, you must pay them final wages and compensation owed, make final federal tax deposits and report employment taxes. Failure to withhold or deposit employee income, Social Security and Medicare taxes can result in full personal liability for what’s known as the Trust Fund Recovery Penalty.

If you’ve paid any contractors at least $600 during the calendar year in which you close your business, you must report those payments on Form 1099-NEC, “Nonemployee Compensation.”

You may face more obligations

If your business has a retirement plan for employees, you’ll generally need to terminate the plan and distribute benefits to participants. There are detailed notice, funding, timing and filing requirements that must be met when terminating a plan. There are also complex requirements related to flexible spending accounts, Health Savings Accounts, and other programs for employees.

We can assist you with many other complicated tax issues related to closing your business, including debt cancellation, use of net operating losses, freeing up any remaining passive activity losses, depreciation recapture, and possible bankruptcy issues.

You also must cancel your Employer Identification Number (EIN) and close your IRS business account. In addition, you need to keep business records for a certain amount of time.

If your business is unable to pay all the taxes it owes, we can explain the available payment options to you. Contact us to discuss these responsibilities and get answers to any questions.

Are you buying a business that will have one or more co-owners? Or do you already own one fitting that description? If so, consider installing a buy-sell agreement. A well-drafted agreement can do these valuable things:

Transform your business ownership interest into a more liquid asset,
Prevent unwanted ownership changes, and
Avoid hassles with the IRS.

Agreement basics

There are two basic types of buy-sell agreements: Cross-purchase agreements and redemption agreements (sometimes called liquidation agreements).

A cross-purchase agreement is a contract between you and the other co-owners. Under the agreement, a withdrawing co-owner’s ownership interest must be purchased by the remaining co-owners if a triggering event, such as a death or disability, occurs.

A redemption agreement is a contract between the business entity and its co-owners (including you). Under the agreement, a withdrawing co-owner’s ownership interest must be purchased by the entity if a triggering event occurs.

Triggering events

You and the other co-owners specify the triggering events you want to include in your agreement. You’ll certainly want to include obvious events like death, disability and attainment of a stated retirement age. You can also include other events that you deem appropriate, such as divorce.

Valuation and payment terms

Make sure your buy-sell agreement stipulates an acceptable method for valuing the business ownership interests. Common valuation methods include using a fixed per-share price, an appraised fair market value figure, or a formula that sets the selling price as a multiple of earnings or cash flow.

Also ensure the agreement specifies how amounts will be paid out to withdrawing co-owners or their heirs under various triggering events.

Life insurance to fund the agreement

The death of a co-owner is perhaps the most common, and catastrophic, triggering event. You can use life insurance policies to form the financial backbone of your buy-sell agreement.

In the simplest case of a cross-purchase agreement between two co-owners, each co-owner purchases a life insurance policy on the other. If one co-owner dies, the surviving co-owner collects the insurance death benefit proceeds and uses them to buy out the deceased co-owner’s interest from the estate, surviving spouse or other heir(s). The insurance death benefit proceeds are free of any federal income tax, so long as the surviving co-owner is the original purchaser of the policy on the other co-owner.

However, a seemingly simple cross-purchase arrangement between more than two co-owners can get complicated, because each co-owner must buy life insurance policies on all the other co-owners. In this scenario, you may want to use a trust or partnership to buy and maintain one policy on each co-owner. Then, if a co-owner dies, the trust or partnership collects the death benefit proceeds tax-free and distributes the cash to the remaining co-owners. They then use the money to fund their buyout obligations under the cross-purchase agreement.

To fund a redemption buy-sell agreement, the business entity itself buys policies on the lives of all co-owners and then uses the death benefit proceeds buy out deceased co-owners.

Specify in your agreement that any buyout that isn’t funded with insurance death benefit proceeds will be paid out under a multi-year installment payment arrangement. This gives you (and any remaining co-owners) some breathing room to come up with the cash needed to fulfill your buyout obligation.

Create certainty for heirs

If you’re like many business co-owners, the value of your share of the business comprises a big percentage of your estate. Having a buy-sell agreement ensures that your ownership interest can be sold by your heir(s) under terms that you approved when you set it up. Also, the price set by a properly drafted agreement establishes the value of your ownership interest for federal estate tax purposes, thus avoiding possible IRS hassles.

As a co-owner of a valuable business, having a well-drafted buy-sell agreement in place is pretty much a no-brainer. It provides financial protection to you and your heir(s) as well as to your co-owners and their heirs. The agreement also avoids hassles with the IRS over estate taxes.

Buy-sell agreements aren’t DIY projects. Contact us about setting one up.

If you’re selling property used in your trade or business, you should understand the tax implications. There are many complex rules that can potentially apply. To simplify this discussion, let’s assume that the property you want to sell is land or depreciable property used in your business, and has been held by you for more than a year.

Note: There are different rules for property held primarily for sale to customers in the ordinary course of business, intellectual property, low-income housing, property that involves farming or livestock, and other types of property.

Basic rules

Under tax law, your gains and losses from sales of business property are netted against each other. The tax treatment is as follows:

1. If the netting of gains and losses results in a net gain, then long-term capital gain treatment results, subject to “recapture” rules discussed below. Long-term capital gain treatment is generally more favorable than ordinary income treatment.

2. If the netting of gains and losses results in a net loss, that loss is fully deductible against ordinary income. (In other words, none of the rules that limit the deductibility of capital losses apply.)

The availability of long-term capital gain treatment for business property net gain is limited by “recapture” rules. Under these rules, amounts are treated as ordinary income, rather than capital gain, because of previous ordinary loss or deduction treatment.

There’s a special recapture rule that applies only to business property. Under this rule, to the extent you’ve had a business property net loss within the previous five years, any business property net gain is treated as ordinary income instead of long-term capital gain.

Different types of property

Under the Internal Revenue Code, different provisions address different types of property. For example:

Section 1245 property. This consists of all depreciable personal property, whether tangible or intangible, and certain depreciable real property (usually real property that performs specific functions). If you sell Section 1245 property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset.
Section 1250 property. In general, this consists of buildings and their structural components. If you sell Section 1250 property that’s placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to depreciation recapture. However, for most noncorporate taxpayers, the gain attributable to depreciation deductions, to the extent it doesn’t exceed business property net gain, will (as reduced by the business property recapture rule above) be taxed at a rate of no more than 28.8% (25% plus the 3.8% net investment income tax) rather than the maximum 23.8% rate (20% plus the 3.8% net investment income tax) that generally applies to long-term capital gains of noncorporate taxpayers.

Other rules apply to, respectively, Section 1250 property that you placed in service before 1987 but after 1980 and Section 1250 property that you placed in service before 1981.

As you can see, even with the simple assumptions in this article, the tax treatment of the sale of business assets can be complex. Contact us if you’d like to determine the tax implications of transactions, or if you have any additional questions.

Choosing the right business entity has many implications, including the amount of your tax bill. The most common business structures are sole proprietorships, partnerships, limited liability companies, C corporations and S corporations.

In some cases, a business may decide to switch from one entity type to another. Although S corporations can provide substantial tax benefits over C corporations in some circumstances, there are potentially costly tax issues that you should assess before making the decision to convert from a C corporation to an S corporation.

Here are four considerations:

1. LIFO inventories. C corporations that use last-in, first-out (LIFO) inventories must pay tax on the benefits they derived by using LIFO if they convert to S corporations. The tax can be spread over four years. This cost must be weighed against the potential tax gains from converting to S status.

2. Built-in gains tax. Although S corporations generally aren’t subject to tax, those that were formerly C corporations are taxed on built-in gains (such as appreciated property) that the C corporation has when the S election becomes effective, if those gains are recognized within five years after the conversion. This is generally unfavorable, although there are situations where the S election still can produce a better tax result despite the built-in gains tax.

3. Passive income. S corporations that were formerly C corporations are subject to a special tax. It kicks in if their passive investment income (including dividends, interest, rents, royalties, and stock sale gains) exceeds 25% of their gross receipts, and the S corporation has accumulated earnings and profits carried over from its C corporation years. If that tax is owed for three consecutive years, the corporation’s election to be an S corporation terminates. You can avoid the tax by distributing the accumulated earnings and profits, which would be taxable to shareholders. Or you might want to avoid the tax by limiting the amount of passive income.

4. Unused losses. If your C corporation has unused net operating losses, they can’t be used to offset its income as an S corporation and can’t be passed through to shareholders. If the losses can’t be carried back to an earlier C corporation year, it will be necessary to weigh the cost of giving up the losses against the tax savings expected to be generated by the switch to S status.

Other issues to explore

These are only some of the factors to consider when switching a business from C to S status. For example, shareholder-employees of S corporations can’t get all the tax-free fringe benefits that are available as a C corporation. And there may be issues for shareholders who have outstanding loans from their qualified plans. These factors must be taken into account in order to understand the implications of converting from C to S status.

If you’re interested in an entity conversion, contact us. We can explain what your options are, how they’ll affect your tax bill and some possible strategies you can use to minimize taxes.

After experiencing a downturn in 2023, merger and acquisition activity in several sectors is rebounding in 2024. If you’re buying a business, you want the best results possible after taxes. You can potentially structure the purchase in two ways:

Buy the assets of the business, or
Buy the seller’s entity ownership interest if the target business is operated as a corporation, partnership or LLC.

In this article, we’re going to focus on buying assets.

Asset purchase tax basics

You must allocate the total purchase price to the specific assets acquired. The amount allocated to each asset becomes the initial tax basis of that asset.

For depreciable and amortizable assets (such as furniture, fixtures, equipment, buildings, software and intangibles such as customer lists and goodwill), the initial tax basis determines the post-acquisition depreciation and amortization deductions.

When you eventually sell a purchased asset, you’ll have a taxable gain if the sale price exceeds the asset’s tax basis (initial purchase price allocation, plus any post-acquisition improvements, minus any post-acquisition depreciation or amortization).

Asset purchase results with a pass-through entity

Let’s say you operate the newly acquired business as a sole proprietorship, a single-member LLC treated as a sole proprietorship for tax purposes, a partnership, a multi-member LLC treated as a partnership for tax purposes or an S corporation. In those cases, post-acquisition gains, losses and income are passed through to you and reported on your personal tax return. Various federal income tax rates can apply to income and gains, depending on the type of asset and how long it’s held before being sold.

Asset purchase results with a C corporation

If you operate the newly acquired business as a C corporation, the corporation pays the tax bills from post-acquisition operations and asset sales. All types of taxable income and gains recognized by a C corporation are taxed at the same federal income tax rate, which is currently 21%.

A tax-smart purchase price allocation

With an asset purchase deal, the most important tax opportunity revolves around how you allocate the purchase price to the assets acquired.

To the extent allowed, you want to allocate more of the price to:

Assets that generate higher-taxed ordinary income when converted into cash (such as inventory and receivables),
Assets that can be depreciated relatively quickly (such as furniture and equipment), and
Intangible assets (such as customer lists and goodwill) that can be amortized over 15 years.

You want to allocate less to assets that must be depreciated over long periods (such as buildings) and to land, which can’t be depreciated.

You’ll probably want to get appraised fair market values for the purchased assets to allocate the total purchase price to specific assets. As stated above, you’ll generally want to allocate more of the price to certain assets and less to others to get the best tax results. Because the appraisal process is more of an art than a science, there can potentially be several legitimate appraisals for the same group of assets. The tax results from one appraisal may be better for you than the tax results from another.

Nothing in the tax rules prevents buyers and sellers from agreeing to use legitimate appraisals that result in acceptable tax outcomes for both parties. Settling on appraised values becomes part of the purchase/sale negotiation process. That said, the appraisal that’s finally agreed to must be reasonable.

Plan ahead

Remember, when buying the assets of a business, the total purchase price must be allocated to the acquired assets. The allocation process can lead to better or worse post-acquisition tax results. We can help you get the former instead of the latter. So get your advisor involved early, preferably during the negotiation phase.

Let’s say you plan to use a C corporation to operate a newly acquired business or you have an existing C corporation that needs more capital. You should know that the federal tax code treats corporate debt more favorably than corporate equity. So for shareholders of closely held C corporations, it can be a tax-smart move to include in the corporation’s capital structure:

Some third-party debt (owed to outside lenders), and/or
Some owner debt.

Tax rate considerations

Let’s review some basics. The top individual federal income tax rate is currently 37%. The top individual federal rate on net long-term capital gains and qualified dividends is currently 20%. On top of this, higher-income individuals may also owe the 3.8% net investment income tax on all or part of their investment income, which includes capital gains, dividends and interest.

On the corporate side, the Tax Cuts and Jobs Act (TCJA) established a flat 21% federal income tax rate on taxable income recognized by C corporations.

Third-party debt

The non-tax advantage of using third-party debt financing for a C corporation acquisition or to supply additional capital is that shareholders don’t need to commit as much of their own money.

Even when shareholders can afford to cover the entire cost with their own money, tax considerations may make doing so inadvisable. That’s because a shareholder generally can’t withdraw all or part of a corporate equity investment without worrying about the threat of double taxation. This occurs when the corporation pays tax on its profits and the shareholders pay tax again when the profits are distributed as dividends.

When third-party debt is used in a corporation’s capital structure, it becomes less likely that shareholders will need to be paid taxable dividends because they’ll have less money tied up in the business. The corporate cash flow can be used to pay off the corporate debt, at which point the shareholders will own 100% of the corporation with a smaller investment on their part.

Owner debt

If your entire interest in a successful C corporation is in the form of equity, double taxation can arise if you want to withdraw some of your investment. But if you include owner debt (money you loan to the corporation) in the capital structure, you have a built-in mechanism for withdrawing that part of your investment tax-free. That’s because the loan principal repayments made to you are tax-free. Of course, you must include the interest payments in your taxable income. But the corporation will get an offsetting interest expense deduction — unless an interest expense limitation rule applies, which is unlikely for a small to medium-sized company.

An unfavorable TCJA change imposed a limit on interest deductions for affected businesses. However, for 2024, a corporation with average annual gross receipts of $30 million or less for the three previous tax years is exempt from the limit.

An example to illustrate

Let’s say you plan to use your solely owned C corporation to buy the assets of an existing business. You plan to fund the entire $5 million cost with your own money — in a $2 million contribution to the corporation’s capital (a stock investment), plus a $3 million loan to the corporation.

This capital structure allows you to recover $3 million of your investment as tax-free repayments of corporate debt principal. The interest payments allow you to receive additional cash from the corporation. The interest is taxable to you but can be deducted by the corporation, as long as the limitation explained earlier doesn’t apply.

This illustrates the potential federal income tax advantages of including debt in the capital structure of a C corporation. Contact us to explain the relevant details and project the tax savings.

Newer Posts

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Reasons an LLC Might be the Ideal Choice for Your Small to Medium-Size Business

Navigating Tax Complexities: Craft Partnership Agreements and LLC Operating Agreements with Precision

Understanding Taxes on Real Estate Gains

The Possible Tax Landscape for Businesses in the Future

Closing a Business Involves a Number of Tax Responsibilities

If Your Business has Co-Owners, You Probably Need a Buy-Sell Agreement

Be Aware of the Tax Consequences of Selling Business Property

Should You Convert Your Business from a C to an S Corporation?

Tax Tips When Buying the Assets of a Business

The Tax Advantages of Including Debt in a C Corporation Capital Structure

May 2025 Tax Deadlines

Are You a Tax-Favored Real Estate Professional?

Six Essential Tips for Small Business Payroll Tax Compliance

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