Structuring Your Company For Tax Efficiency Can Be Extremely Worthwhile

John McAlister

By John McAlister, Vice President at The Beringer Group

As a successful business owner, you are faced with important decisions every day, which can sometimes make it difficult to focus on the larger issues that impact your business. For example, when was the last time you considered how your business is taxed? Taking the time to explore how to structure your company for maximum tax efficiency could be extremely worthwhile.

Business structures and the corresponding taxes are varied. There are Sole Proprietorships, Regular “C” corps (all company taxes are paid at the corporate level), and “Pass-Through” entities such as S Corps and Limited Liability Companies (LLCs), where all income taxes are paid on a pro-rata basis to each shareholder.

Many family businesses start out being taxed as a C corporation to preserve precious working capital inside the company as it grows. However, as time passes, the cash accounts can grow quite large and the owners may hesitate to declare a dividend because they are first taxed at the corporate level, and then again to each shareholder — hence the term, double taxation.

In a Pass-Through entity, all income taxes are paid by the shareholder on a pro-rata basis regardless of whether the profits are distributed. Any undistributed profit not paid to the shareholder remains in an account called the Accumulated Adjustment Account or Triple-A account. These funds may be withdrawn at will without additional income taxes because they have been paid.

More family-owned businesses are transitioning to an Employee Stock Ownership Plan (ESOP) model of ownership. An ESOP is a tax-qualified, broad-based retirement plan that allows current and future employees to gradually acquire beneficial ownership of the company. This ownership grows tax-free until it is paid out. ESOPs can be structured as either S Corporations or C Corporations. For S Corporations, distributions paid on stock held in the ESOP are not tax-deductible. In contrast, C Corporation dividends distributed on ESOP-held stock are tax-deductible if they are used to repay an ESOP loan or distributed directly to employees.

Depending on the owners’ exit strategy, an ESOP can offer a tax-efficient method for transferring ownership. However, this business structure has many complex aspects, so it is advisable to consult with a qualified professional who can conduct an ESOP feasibility study to determine if it is the right fit for your business.

An additional means to consider pertaining to tax efficiency for your business is through the use of the Pass-Through Taxable Entity Tax (P-T-E-T), which has now been adopted by most states to help offset the $10,000 State and Local Tax (SALT) cap. Using the PTET deduction is an individual decision and should be discussed with your CPA to determine if you qualify and if it is a good fit.

Large family enterprises have tax efficiency discussions with their CPAs and other financial advisors several times each year. You might think that having a personal discussion with your CPA is a waste of money if you own a smaller company. However, if you and any other shareholders are unclear about your goals or the purpose of making profits, you may not end up where you expected.

Many economic pundits predict income taxes will increase in coming years to help balance the federal budget and reduce rising deficits. This is why it is important for business owners like yourself to take a step back and examine the big picture. Taking the time to be proactive will not only increase your tax savings but will also help you accomplish what matters to you most, growing your business and achieving your goals.

John McAlister, Vice President at The Beringer Group, is dedicated to helping family business owners succeed. With over 25 years of experience, he has helped hundreds of family businesses maximize their tax savings. John understands that each family business is unique and provides custom solutions to meet your specific needs. Find out how he can support you and your family business today. Visit theberingergroup.com.