Pub. 7 2018 Issue 3

l e a d i n g a d v o c a t e f o r t h e b a n k i n g i n d u s t r y i n k a n s a s 18 REGULAR VS SUB-S “CLEAR AS MUD” By Tom Hintz, Strategic Advisor, Varney and Associates Now that corporate rates have been reduced to 21%, is it time to void the Sub-S election? Great question! The answer involves a number of factors: 1. Does most of the income need to be retained or can it be paid out to shareholders? 2. Is there a significant amount of non-taxable income like muni bond income that adds to basis? 3. When will the owners sell and potentially receive the basis increase benefit of Sub-S from undistributed income or non- taxable muni-income? 4. Are there special items on the balance sheet like Company or Bank Owned Life Insurance that could trigger tax on cash surrender value build up if the company is a Sub-S subsidiary and the subsidiary is sold? Deferred compensation plans also can be an issue. 5. Are there appreciating assets such as real estate that could create double tax if a regular corporation is used? (Generally not an issue for a bank). 6. What are the effective tax rates of the owners? 7. Will the investment tax of 3.8% be an issue? Investment income tax is on dividends, gains and Sub-S income if a passive investment and income exceeds $250,000. We have attempted to create an illustration of Sub S vs regular using a side by side comparison that could be used as a model to begin to answer the questions. Some preliminary answers would be: 1. If the need is to keep the income in the corporation for a long-period of time and not sell, then a regular corporation may be the answer as it avoids the tax on dividends and the possible investment tax. 2. If non-taxable muni-income is significant then the basis increase from Sub S could be the answer. 3. Low effective tax rates of the owners would favor Sub-S. 4. Flexibility or changing circumstances would favor Sub-S as once the election is voided, the election cannot be made for a period of five years. However, to control the amount taxable to an individual to different years, then regular could be the answer by the use of varying dividends. 5. Appreciating assets are best in a Sub-S to avoid double tax on sale if the proceeds are also distributed to owners. Obviously, which entity to use is very circumstantial and deserves some thought and “what-if ” type of analysis. Generally, the Sub S election should be retained unless circumstances have changed significantly. Isn’t tax “simplification” fun and clear? Tom Hintz is a strategic advisor with Varney and Associates, CPA’s, a CPA and advisory firm based in Manhattan, Kansas