• COVID-19
  • Insights
  • Who We Help
    •   Industrial Automation
    •   Manufacturing & Distribution
    •   A&E Professional Services
    •   International Businesses
      • ◦   Expanding Outside the U.S.
      • ◦   Expanding to the U.S.
  • Services
    •   COVID-19
      • ◦   Cash Flow Confidence Assessment
      • ◦   Maximize Your Loan Forgiveness
      • ◦   5 Key Focus Areas
      • ◦   COVID-19 Resource Center
    •   Client Accounting
      • ◦   Software Solutions
      • ◦   Accounting Support
      • ◦   Reporting
    •   Tax
      • ◦   R&D Tax Credit
      • ◦   Tax Credits & Incentives
      • ◦   Tax Structure
      • ◦   Federal Tax
      • ◦   State & Local Tax
      • ◦   Personal Tax
      • ◦   Other Tax Filings
    •   Advisory & Assurance
      • ◦   Assurance Levels
      • ◦   Reporting
      • ◦   Employee Benefit Plan Audits
      • ◦   Technical Accounting & Reporting
    •   Consulting
      • ◦   Data Analytics
      • ◦   Transaction Services
      • ◦   Business Planning
      • ◦   Succession & Exit Strategies
    •   International
      • ◦   International Tax
      • ◦   Foreign Direct Investment
      • ◦   Global Expansion
      • ◦   International Accounting
  • Events
  • Careers
    •   Why C&M
    •   Students
      • ◦   Campus Events
      • ◦   Internships
      • ◦   Reach Beyond Program
    •   Experienced Professionals
      • ◦   Team member profile videos
    •   Opportunities
    •   Employee Journals
    •   Office Tour
  • About Us
    •   How We Help
      • ◦   Service Approach
      • ◦   Affiliations
      • ◦   Communications & Technology
    •   Meet Our Team
    •   Testimonials
    •   Our Videos
    •   Our Story
  • Contact Us
  • Subscribe
CHANGE COUNTRY:
  • United States
  • 中国
  • Client Login
Clayton & McKervey Logo
  • COVID-19
  • Insights
  • Who We Help
  • Services
  • Events
  • Careers
  • About Us
  • Contact Us
  • Subscribe
    • Most Recent Insights
  1. Home
  2. Insights
  3. C-Corp vs. S-Corp: Tax Reform and R&E Credits

C-Corp vs. S-Corp: Tax Reform and R&E Credits

Posted by Sarah Russell and Tim Finerty on November 2, 2018

Sarah Russell Sarah Russell

Tax Reform
The passing of the 2017 Tax Cuts and Jobs Act has many closely held business owners raising the question, “Should I convert to a C corporation?” On the surface, with the corporate tax rate now at a flat 21% and the highest individual tax rate at 37%, it would seem to be a “no brainer” that business owners would benefit by converting to corporations. However, additional factors should be considered before making such big decision. Such factors include:

  • Does the business qualify for the pass-through deduction?
  • Is the business generating research credits?
  • Will the business pay dividends to its owners?
  • What is the long-term exit strategy?

Looking at the first two factors, the pass-through deduction provides a 20% deduction on qualified business income. If business owners qualify for this deduction the tax rate on business income that flows to their personal return will be reduced from 37% to 29.6%.

For many profitable businesses who pay wages to the business owner(s), beginning in 2018, their tax liability will look similar to the example provided in Figure 1:

Figure 1 12/31/2018
C-Corp S-Corp
Corporation Income 500,000 500,000
Wages 250,000 250,000
Total Income 750,000

Income Tax: 21%
Business Income 105,000 148,000
Wages 92,500 92,500
Total Tax Due 197,500 240,500

When we consider the benefits of the reduced corporate tax rate, it appears that being a C-Corp is more favorable, even with the flow through deduction for partnerships and S-Corps. However, this doesn’t take into account companies that generate Research and Experimentation (R&E) tax credits.

Research and Experimentation Tax Credits
One common misconception about the 2017 tax law is that the R&E credit has gone away, which is not true. The R&E credit continues to be one of the best tools a taxpayer has to reduce their federal tax liability to a minimum tax rate, usually around 7.5%.

The basic premise of the R&E credit is that a business developing new or improved products, processes or techniques, can generate credits based on their qualifying research expenditures for that year. This includes wages, supply costs and contract research.

Figure 2 below, shows that when the R&E credit added to the above example, changing from a partnership or S-Corp to a C-Corp may not be the best solution.


Figure 2
12/31/2018
C-Corp S-Corp
Corporation Income 500,000 500,000
Wages 250,000 250,000
= Total Income 750,000

Income Tax:
Business Income (21%) 105,000 148,000
Wages 92,500 92,500
= Tax Liability before Credits 197,500 240,500
R&E Credits Generated 150,000 150,000
Maximum Credits Utilized 67,500 150,000
= Total Tax Due 130,000 90,500

R&E as a Tax Savings Tool
Here we see that utilizing the R&E credit results in a significant reduction of tax liability for the S-Corp or partnership, which raises another common question: “How does a flow through entity utilize a dramatically larger credit compared to the C-Corp if the amount of credit generated is the same in both entities?” The answer lies in the way the tax law is written. R&E credits generated by a business can be used to offset any income generated from that same business activity.

C-Corp
For a C-Corp, income generated is generally limited to the income of that business, therefore, the wages paid to the owner(s) cannot be offset by the credit. Additionally, if the business incurs a net loss for the year, credits can still generate, but there is no income to offset with those generated credits.

S-Corp
For an S-Corp or partnership, the income generated does not only include the business income, but also any wages, guaranteed payments and interest paid to owners. Even if the business incurs a loss, if wages were paid to owners, owners can still offset wage income with credits generated during the year.

In the example outlined above, for a C-Corp only the income tax reported on the business tax return can be reduced to a 7.5% minimum tax rate, and the wages paid are taxed at the 37% individual tax rate. $500,000 × 7.5% = $37,500. $200,000 × 37% = $92,500. $37,500 + $92,500 = $130,000. For the S Corp, both the business income and the wages can be reduced to a 7.5% minimum tax rate if the business generated enough credits. In this example federal tax could be reduced to as low as $56,250 because only $150,000 of R&E credits were generated, and the federal tax liability was reduced to $90,500.

Utilizing the R&E credit is a powerful tool business owners have to offset their tax liability, even under the new tax law. Before making the decision to change to a corporation, it is important to consider and have a conversation about the R&E Credit.

If you think it may make sense to convert to a C corporation but also believe you may qualify for R&E credits, or may not have utilized the credit to its fullest extent in prior years, contact Clayton & McKervey Shareholders Sarah Russell or Tim Finerty for a free assessment to determine your potential R&E credit.

Our team is always ready to help.

Please contact us for more information.

Sarah Russell

Sarah Russell

Shareholder, Tax

Contact Sarah   |   Read Sarah's bio

Tim Finerty

Shareholder, Industrial Automation

Contact Tim   |   Read Tim's bio

related news

How to Calculate R&D Tax Credits

As we’ve seen in the first two installments of this series, business owners often miss out on the R&D tax credit opportunity and the bottom-line infusion it can provide. Many…

Read full story

Doing Business in Mexico: What to Expect this Year

Without a doubt, this year will be interesting for Mexico. To start, it’s an election year and we all know what that means…a lot of uncertainty. As the global pandemic…

Read full story

What Expenses Qualify for R&D Tax Credits?

The R&D tax credit is one of the most overlooked opportunities to boost your bottom line. Many business owners fail to claim it under the mistaken belief that they’re not…

Read full story

Clayton & McKervey Launches The Sound of Automation Podcast

Media Contact: Denise Asker, dasker@claytonmckervey.com; 248.936.9488 Southfield, Mich.—February 17, 2021—Clayton & McKervey, a certified public accounting and business advisory firm helping growth-driven companies compete in the global marketplace, is excited…

Read full story

Misconceptions About the Research & Experimentation Tax Credit

As companies put more emphasis on Industry 4.0 and business processes become more automated and accessible, the opportunities for Research & Experimentation tax credits increase. The Research and Experimentation (R&E)…

Read full story

Categories

Jump directly to the topics that matter to you most.

  • A&E Professional Services
  • About Us
  • Advisory & Assurance
  • Business Owners
  • C&M Press Releases
  • Careers
  • China Consulting
  • Clayton & McKervey
  • Client Accounting Services
  • Consulting
  • COVID-19
  • Data Analytics
  • Estate Planning
  • Expanding Outside the U.S.
  • Expanding to the U.S.
  • From the President
  • Industrial Automation
  • International
  • Manufacturing & Distribution
  • Mexico Consulting
  • Podcasts
  • Private Client Services
  • Tax & Tax Credits
  • Transaction Services
  • Videos

Authors

Read news direct from our managers and stakeholders.

    • Ben Smith
    • Beth Butchart
    • Bryan Powrozek
    • Carlos Calderon
    • Casey Haggerty
    • Clayton & McKervey
    • Dave Van Damme
    • Denise Asker
    • Eric Lin
    • Jim Biehl
    • Julie Killian
    • Kevin Johns
    • Margaret Amsden
    • Miroslav Georgiev
    • Nina Wang
    • Rob Dutkiewicz
    • Ruben Ramirez
    • Sarah Russell
    • Sue Tuson
    • Tarah Ablett
    • Teresa Gordon
    • Tim Finerty
    • Tim Hilligoss
    • Wendy Reedy

Additional Resources

Additional news from Clayton & McKervey can be found below.

  • Subscribe to our email newsletter
  • View upcoming events
  • Contact us to let us know how we can help you
  • Main Content
  • Related Insights

C-Corp vs. S-Corp: Tax Reform and R&E Credits

Posted by Sarah Russell and Tim Finerty on November 2, 2018

Sarah Russell

Tax Reform
The passing of the 2017 Tax Cuts and Jobs Act has many closely held business owners raising the question, “Should I convert to a C corporation?” On the surface, with the corporate tax rate now at a flat 21% and the highest individual tax rate at 37%, it would seem to be a “no brainer” that business owners would benefit by converting to corporations. However, additional factors should be considered before making such big decision. Such factors include:

  • Does the business qualify for the pass-through deduction?
  • Is the business generating research credits?
  • Will the business pay dividends to its owners?
  • What is the long-term exit strategy?

Looking at the first two factors, the pass-through deduction provides a 20% deduction on qualified business income. If business owners qualify for this deduction the tax rate on business income that flows to their personal return will be reduced from 37% to 29.6%.

For many profitable businesses who pay wages to the business owner(s), beginning in 2018, their tax liability will look similar to the example provided in Figure 1:

Figure 1 12/31/2018
C-Corp S-Corp
Corporation Income 500,000 500,000
Wages 250,000 250,000
Total Income 750,000

Income Tax: 21%
Business Income 105,000 148,000
Wages 92,500 92,500
Total Tax Due 197,500 240,500

When we consider the benefits of the reduced corporate tax rate, it appears that being a C-Corp is more favorable, even with the flow through deduction for partnerships and S-Corps. However, this doesn’t take into account companies that generate Research and Experimentation (R&E) tax credits.

Research and Experimentation Tax Credits
One common misconception about the 2017 tax law is that the R&E credit has gone away, which is not true. The R&E credit continues to be one of the best tools a taxpayer has to reduce their federal tax liability to a minimum tax rate, usually around 7.5%.

The basic premise of the R&E credit is that a business developing new or improved products, processes or techniques, can generate credits based on their qualifying research expenditures for that year. This includes wages, supply costs and contract research.

Figure 2 below, shows that when the R&E credit added to the above example, changing from a partnership or S-Corp to a C-Corp may not be the best solution.


Figure 2
12/31/2018
C-Corp S-Corp
Corporation Income 500,000 500,000
Wages 250,000 250,000
= Total Income 750,000

Income Tax:
Business Income (21%) 105,000 148,000
Wages 92,500 92,500
= Tax Liability before Credits 197,500 240,500
R&E Credits Generated 150,000 150,000
Maximum Credits Utilized 67,500 150,000
= Total Tax Due 130,000 90,500

R&E as a Tax Savings Tool
Here we see that utilizing the R&E credit results in a significant reduction of tax liability for the S-Corp or partnership, which raises another common question: “How does a flow through entity utilize a dramatically larger credit compared to the C-Corp if the amount of credit generated is the same in both entities?” The answer lies in the way the tax law is written. R&E credits generated by a business can be used to offset any income generated from that same business activity.

C-Corp
For a C-Corp, income generated is generally limited to the income of that business, therefore, the wages paid to the owner(s) cannot be offset by the credit. Additionally, if the business incurs a net loss for the year, credits can still generate, but there is no income to offset with those generated credits.

S-Corp
For an S-Corp or partnership, the income generated does not only include the business income, but also any wages, guaranteed payments and interest paid to owners. Even if the business incurs a loss, if wages were paid to owners, owners can still offset wage income with credits generated during the year.

In the example outlined above, for a C-Corp only the income tax reported on the business tax return can be reduced to a 7.5% minimum tax rate, and the wages paid are taxed at the 37% individual tax rate. $500,000 × 7.5% = $37,500. $200,000 × 37% = $92,500. $37,500 + $92,500 = $130,000. For the S Corp, both the business income and the wages can be reduced to a 7.5% minimum tax rate if the business generated enough credits. In this example federal tax could be reduced to as low as $56,250 because only $150,000 of R&E credits were generated, and the federal tax liability was reduced to $90,500.

Utilizing the R&E credit is a powerful tool business owners have to offset their tax liability, even under the new tax law. Before making the decision to change to a corporation, it is important to consider and have a conversation about the R&E Credit.

If you think it may make sense to convert to a C corporation but also believe you may qualify for R&E credits, or may not have utilized the credit to its fullest extent in prior years, contact Clayton & McKervey Shareholders Sarah Russell or Tim Finerty for a free assessment to determine your potential R&E credit.

Our team is always ready to help.

Please contact us for more information.

Sarah Russell

Shareholder, Tax

Contact Sarah   |   Read Sarah's bio

Tim Finerty

Shareholder, Industrial Automation

Contact Tim   |   Read Tim's bio

related news

How to Calculate R&D Tax Credits

As we’ve seen in the first two installments of this series, business owners often miss out on the R&D tax credit opportunity and the bottom-line infusion it can provide. Many…

Read full story

Doing Business in Mexico: What to Expect this Year

Without a doubt, this year will be interesting for Mexico. To start, it’s an election year and we all know what that means…a lot of uncertainty. As the global pandemic…

Read full story

What Expenses Qualify for R&D Tax Credits?

The R&D tax credit is one of the most overlooked opportunities to boost your bottom line. Many business owners fail to claim it under the mistaken belief that they’re not…

Read full story

Clayton & McKervey Launches The Sound of Automation Podcast

Media Contact: Denise Asker, dasker@claytonmckervey.com; 248.936.9488 Southfield, Mich.—February 17, 2021—Clayton & McKervey, a certified public accounting and business advisory firm helping growth-driven companies compete in the global marketplace, is excited…

Read full story

Misconceptions About the Research & Experimentation Tax Credit

As companies put more emphasis on Industry 4.0 and business processes become more automated and accessible, the opportunities for Research & Experimentation tax credits increase. The Research and Experimentation (R&E)…

Read full story

Categories

Jump directly to the topics that matter to you most.

  • A&E Professional Services
  • About Us
  • Advisory & Assurance
  • Business Owners
  • C&M Press Releases
  • Careers
  • China Consulting
  • Clayton & McKervey
  • Client Accounting Services
  • Consulting
  • COVID-19
  • Data Analytics
  • Estate Planning
  • Expanding Outside the U.S.
  • Expanding to the U.S.
  • From the President
  • Industrial Automation
  • International
  • Manufacturing & Distribution
  • Mexico Consulting
  • Podcasts
  • Private Client Services
  • Tax & Tax Credits
  • Transaction Services
  • Videos

Authors

Read news direct from our managers and stakeholders.

  • Ben Smith
  • Beth Butchart
  • Bryan Powrozek
  • Carlos Calderon
  • Casey Haggerty
  • Clayton & McKervey
  • Dave Van Damme
  • Denise Asker
  • Eric Lin
  • Jim Biehl
  • Julie Killian
  • Kevin Johns
  • Margaret Amsden
  • Miroslav Georgiev
  • Nina Wang
  • Rob Dutkiewicz
  • Ruben Ramirez
  • Sarah Russell
  • Sue Tuson
  • Tarah Ablett
  • Teresa Gordon
  • Tim Finerty
  • Tim Hilligoss
  • Wendy Reedy

Additional Resources

Additional news from Clayton & McKervey can be found below.

  • Subscribe to our email newsletter
  • View upcoming events
  • Contact us to let us know how we can help you

Website

  • COVID-19
  • Insights
  • Who We Help
  • Services
  • Events
  • Careers
  • About Us
  • Contact Us
  • Subscribe

Location

+1 248.208.8860
2000 Town Center
Suite 1800
Southfield, MI
48075 | USA

Connect

  • Events
  • Newsletter
  • Client Login

Social

  • LinkedIn
  • Facebook
  • Twitter
  • Glassdoor
  • YouTube
  • Instagram

Awards

DFP Top Work Places Best & Brightest
Prime Global

Tax | Accounting | Assurance | Consulting | Highly technical and accessible team of CPAs helping growth driven, closely held, middle market companies compete in the global marketplace. Michigan-based accountants and advisors focused on helping business owners in the United States and throughout Europe and China.

Privacy Policy Disclaimer

© 2021 Clayton & McKervey