By Dr. James M. Dahle, WCI Founder
In my last post, I talked about how excited I was about C Corporations after learning some more about them in a book. Then reality set in. The more I read, the more I realized the IRS had already thought of every loophole I hoped to exploit to take advantage of this knowledge. Let's go through them one by one. They'll probably help you realize you don't need or want a C Corp either.
It Costs a Lot of Time and Money to Start, Maintain, and Liquidate a C Corp
There are lots of complicated legal and accounting steps to take to start, run, and liquidate a corporation. Unlike an LLC, this isn't really a do-it-yourself kind of area. At a minimum, you're probably going to need to hire a corporate attorney and an accountant. You have to weigh any tax advantages (the main point of a C Corp over another type of corporation) against the costs of incorporating.
C Corps Are for Real Businesses
If you're not interested in running a business, you don't want a C Corp. If you're just looking for some asset protection, a tax break on your physician salary, or tax savings on your investment account, (my goals) you should probably look into some other strategies.
Why Not Run 5 Different C Corps?
So the first tax avoidance scheme I thought up was “Why not just make 5 (or more) C Corps and have them each make just $50K?” That way none of the corporations has to pay more than 15% in tax. Well, the IRS is smarter than they look. They have something called Controlled Group Status, which basically says that if two corporations are owned by the same people, they'll be treated as one corporation. Plot foiled.
The IRS Hates Doctors
Don't feel too badly, they hate lawyers too. The benefits of a C Corp were just too tasty for highly paid professionals, so the IRS came up with a designation called a Professional Services Corporation (PSC). All PSCs are C Corps, but not all C Corps are PSCs. For the most part, you don't want to be a PSC because a PSC doesn't get to benefit from the C Corp tax brackets. Instead, it gets its own flat tax bracket – 35%. That doesn't sound so good, does it. Instead of getting to benefit from the graduated tax brackets on the personal income tax return, or the graduated tax brackets on the corporate tax return, you get a flat tax. It wouldn't be so bad if it was flat at 20 or 25%. But at 35%? I can't think of very many doctors that would benefit from that.
So your main goal with a C Corp is to AVOID being designated a PSC. There are two tests that determine you're a PSC. First, an ownership test. If the corporation's stock is substantially held by qualifying professionals who are currently (or previously) performing professional services (like doctoring) for the corporation, you pass! Second, the function test. >95% of the business activity of the corporation has to be professional services. I suppose you get out of this one if you could somehow combine the medical practice with another business (such a very profitable blog), but I don't know how I'd get around the ownership test.
So that pretty much rules out any tax benefits to me of using a C Corp for my medical practice. Some doctors do use these things, of course, but they just pay all the profits to themselves as a salary so there's nothing left to be taxed at 35% within the corporation.
Personal Holding Company
Then I got to thinking that at least I could use a C Corp to hold investments. That could eliminate 70%-100% of the tax due on investment dividends. Unfortunately, the IRS is again one step ahead of me. A Personal Holding Company is a corporation that has 60% or more of its income from personal holding income (dividends, interest etc) and has 5 or fewer individuals owning at least 50% of the stock. Unless I want to start a Berkshire-Hathaway, I'm out of luck again. Could I form a C Corp for this blog and then put some investments in it (keeping income to less than 60%)? Yes. But the point is there has to be a real business there. No business…no corporation. Given that I have plenty of other tax-protected accounts available to invest in, and the Retained Earnings Tax, I still don't see much reason for me to form a C Corp.
Retained Earnings Tax
It turns out that if you keep more than $250K in a business that you don't need for business operations ($150K in PSCs), then you have to pay a 39.6% tax on it as a an accumulated earnings tax. So basically, you've got to pay out those earnings as salary/bonus or as a dividend or else you get walloped with a fat tax. So much for using a corporation as a savings vehicle.
I hope I didn't get your hopes up too high with the previous post, just to dash them with this one.