C Corporations - The shield of the Crypto Earner
Crypto Earners and Tax structures, Pt 2.
Disclaimer
None of the following is tax advice, it is just prompting the reader towards ideas, topics and questions for their own research or to bring up with a tax professional. Your own family situation, goals and residence have a tremendous impact on your specific tax plans so DYOR, and at least consult a tax pro if you can afford it.
Overview
Choosing a C corporation structure as a self employment vehicle, especially as a crypto earner seems like a crazy idea from the outset. It is unorthodox, like the idea of arming yourself with a large heavy shield. It’s slow, income inefficient and an administrative burden. You are going to be more nimble and dangerous if you arm yourself with a sword or a spear for example, but that isn’t the point of choosing a shield. You choose a shield because you are going for protection versus damage output, you are in essence trying to “tank” the tax system, which is what a C corporation does.
Despite the tax and administrative drawbacks, C corporation structures provide a tax firewall, more privacy than other structures, data minimization, charitable deductions, mortgage and loan planning. You are powering through bad tax rates, for these other benefits.
Tax inefficient
Let’s get the negatives out of the way first. C corporations have a 21 percent tax rate at the federal level, with most states having another 5 percent on top of that. That is on the first dollar, there are no standard deductions and no small business deductions. There are no special capital gains tax rates either.
Once you have that tax covered, paying out profits as dividends can create another 0-20 percent tax on the individual receiving them. That is pretty terrible, but it wasn’t always that way. Prior to the advent of the tax cuts and jobs act there was a graduated tax rate and the first $50,000 of corporate income was only taxed at 15% but was up to over 30% once you crossed $75,000. The change to a flat 21% did free up corporation owners from another trap though and that was PSC tax.
PSC known as Personal Service Corporation is in short a designation for corporations that provide consulting type services through a corporation that is owned by a small group of people. A PSC had to pay tax at the highest income rate at the time, which luckily today is 21%.
In addition to the PSC risk, there is also the Personal Holding Company risk, in which a corporation is designated as such because it earns more than 60 percent of its income via certain specified types of passive income. It carries an additional 20 percent tax on undistributed income in addition to corporate income tax.
Administrative Burden
In addition to the uphill climb on taxes, there is a larger administrative burden to running a corporate structure than a sole proprietor structure. There needs to be corporate minutes and records kept, annual secretary of state filings completed, and separate tax filings done. You’ll probably also need to run payroll and accounting can be more complex as earnings and profits need to be recorded as well as a balance sheet.
Corporate structures also tend to make it harder to open bank accounts, investment accounts, centralized exchange accounts and insurance. They have to be opened through commercial service providers and require more information than your run of the mill KYC for individuals. This burden though is the same burden for Trusts, Partnerships and S Corporations.
On the positive, Corporations are administratively beneficial for ownership changes and longevity. As long as the state filings are completed each year, they ‘stay alive’ forever and ownership changes are reflected simply in the exchange of shares.
Tax quirks
Now that you have made it through all of the negatives of a corporate structure, I’d like to cover the benefits, starting with the positive tax quirks.
First, C corporations can do stock buybacks which is the corporation using funds to purchase stock from shareholders. This creates a capital gain transaction with a basis deduction which is useful depending on the shareholder’s basis. The second and biggest tax benefit of C corporations comes through the Qualified Small Business Tax Exclusion. This allows corporate business stock to be sold for ZERO capital gains tax as long as it is held for 5 years and isn’t an excluded type of business. The gain can be up to 50 million dollars. Third, it is easy to use a non-calendar year for a C corporation. A non-calendar year, known as a fiscal year, allows for some tax planning and timing of income or distributions in conjunction with a shareholder’s calendar year end. It also allows for more even cash flow planning if the corporation had taxes due on September 30, but the shareholders don’t pay theirs until April 15.
On a state tax level, corporate structures allow for the easiest apportionment. Apportionment is allocating income among various states, which is helpful if a corporation has a presence in a low tax state. Furthermore, Corporations can deduct state taxes fully where and individual is currently limited to a cap of $10,000 in state taxes. This is helpful if you live in a tax prison like CA or NY.
The last quirk, which I like the most, is the deduction of charitable giving for C Corporations. Charitable giving for tax benefits is essentially a waste of time for any other tax structure under current tax law as the ‘standard deduction’ makes the threshold to claim anything very high. However, a C Corporation can deduct charitable gifts like a normal business deduction all of the way up to 10% of it’s net profits. Even if it goes beyond that 10 percent, it can carry the unused amount forward to another year.
Tax liability shield
A unique aspect of a C corporation that is not afforded to a sole proprietorship, an S corporation or a partnership is that a C corporation is liable for it’s own taxes. With the other business structures the income and tax liability for the business passes through to the shareholders. If you can’t pay the tax, too bad, it is attached to you personally. With a C corporation if it can’t pay the tax, the corporation goes bankrupt and loses all of it’s assets but the shareholders are unaffected. There is an exception for payroll taxes but that is all. That tax liability firewall is a great feature for people concerned about tax liabilities and an uncertain cryptocurrency tax future. For example, if tax laws change and virtual assets are taxed at 300 percent, you can simply fold the corporation and limit your losses to corporate holdings instead of being saddled with that debt personally.
Privacy and data protection
Your personal return is only connected to a C corporation return by 1099s for Dividends, and W2’s for payroll. You also get these for normal income from normal jobs, and investments and so your personal return looks quite average when you operate your business as a C corporation and you carry a ‘self employed’ data profile. This is helpful for doing computerized loan or mortgage applications as your tax profile looks more average than someone with pass through business income and you can avoid being kicked out by underwriting for being ‘self employed’. The C Corp return itself will identify you as an officer, and a more than 25% shareholder so you don’t get total anonymity. There are plans to add more disclosures connecting shareholders to a corporation, but they aren’t here yet. This is profile is great compared to partnerships, s corps and sole props which pass all data down onto you’re your personal tax return. Last, for corporations there is also no crypto checkbox on their tax returns, meaning that there is no flag that will identify your corporate return as using cryptocurrency.
Best income level to use.
The most tax efficiencies for C corporations come when you have the option to skip years of dividends or run out enough time for stock holding time for the qualified small business tax break. This means your other income would have to carry you through off years. In general, a good income level is when your personal income tax bracket is beyond the corporate tax rate, and better if it is above the 30% bracket of roughly $170,000 for single filers. On the state level, don’t use the C corporation if you live in California or any other state that taxes dividends at ordinary income rates.
Remember though, the advantages of tax firewalling and other quirks are more likely to make someone choose a C corporation over simply income tax tradeoffs.