What's the Best Corporate Structure for Your Company?
by Shel Horowitz
Choice was the watchword during the second half of November's Family Business Center gathering, as experts from the Center's sponsors held court in different corners. Attenders got to choose two sessions out of five. My two picks were attorney Ron Weiss, of Bulkley, Richardson and Gelinas, LLP, and Sovereign Bank's Joe Shaw.
Weiss focused on the tax implications for Massachusetts corporations. An S corporation that grosses more than $6 million in a year faces a severe "sting tax" under Massachusetts law starting at 3% of net income and rising to 4.5% if receipts exceed $9 million. This tax is on top of the personal income tax the shareholders are already paying on the same income. And no, you can't avoid this tax by subdividing your corporation into smaller ones. If the corporations have the same owner, the state adds the receipts together and you have to pay.
There is a solution, however: setting up a "Massachusetts business trust," to own the shares of your corporation. With proper tax elections, the IRS will treat the trust as a continuation of your corporation, including the S-corporation status, and will disregard your corporation for tax purposes. Massachusetts will tax the trust at personal income tax levels: 5.85% on ordinary income, 12% on short-term gains, and between 1 and 5% on long-term gains, but the individual shareholders generally won't have to pay taxes on their distributions from the trust.
Thus, the tax on the trust is significantly lower than the combined personal income taxes and sting tax on the S-corporation. While Massachusetts will disregard the corporation for the income measure of the corporate excise tax, the corporation will still have to pay the greater of the property measure of the corporate excise or the minimum corporate excise tax, but manufacturers will be exempt from local personal property taxes.
In other words, while your mileage may vary, there's a good likelihood that, if your gross receipts exceed $6 million, moving to a trust model will save your company a significant chunk in taxes. It's flexible, too; should the law change so that this structure is no longer advantageous, the law allows the trust and the corporation to merge back into a single entity again.
In general, Weiss said, S corporations are generally more tax effective than C corporations for the shareholders of a closely held businesses, "but an S corporation can be hell on an estate plan." If you plan to sell the assets of your business, convert to an S corporation at least ten years ahead of the sale to avoid a double level of taxes when you do sell. For those just starting up, limited liability companies (LLCs) offer even greater advantages (for non-manufacturing businesses). "It's much more flexible, you have lower ongoing legal costs, you don't need shareholders or directors meetings, and there is only a single layer of taxes when you sell the assets of the business. It's worth the several thousand dollars per year of extra payroll taxes it may cost.
Shaw's advice was less technical, more general: keep your banker informed, provide more information than you're asked to, make bankers aware of normal seasonal fluctuations, anticipated capital needs, and other parts of the financial picture. If, for instance, you plan to acquire another business in the future, let the banker know well ahead of time. When you're ready to move, instead of questioning your need for capital, the banker will say, "Oh, finally!" Another bit of good advice. Keep the bank officers a level or two above your immediate contact in the loop. That way if your own banker leaves, there's still someone in a position of authority who knows the particulars of your business, and who will be your ally. Finally, remember that banks look carefully at your EBIT (earnings before interest and taxes) and EBITDA (EBIT plus depreciation and amortization). They want to know how much leverage you have, and these numbers are crucial to determine that.