Slumping company valuations in the trucking industry can help companies save as much as 50 per cent on their income taxes, say two leading transportation industry consultants. The struggling economy’s has created moneymaking opportunities by creating an ideal time for companies to consider changing their status from a ‘C’ corporation to an ‘S’ corporation, according to Barry Tidwell and Kenneth DeWitt.
Tidwell, a partner in Tidwell, Mason and Thomas in Birmingham, Ala., provides tax and business transfer advice and services to trucking companies, among other businesses. DeWitt, a partner in DeWitt & Dyer, Tuscaloosa, Ala., is a CPA and Certified Financial Planner who acts as a part-time chief financial officer for businesses, including trucking companies. Both spoke at the 2002 Randall Trucking Symposium.
“You can put a lot of cash back into your pocket, or back into your business, in the first twelve months after a conversion,” said Tidwell. “I worked with owners of a company doing $9.5 to $10 million in revenue who put $380,000 in cash back into their pockets in that first year after they switched.”
The S corporation is a pass-through entity, said DeWitt. “You get the legal protection of a C corporation but the company is taxed like a partnership. Company pre-tax profit is passed-through to you and taxed on your personal income tax. So you only pay taxes once, and then at a lower total rate.” With a C corporation, said DeWitt, your company is taxed, and when you get income from the company, you are taxed again.
“And if you sell an S corporation, the profit goes into your personal account and you get taxed at the capital gains rate of 20 per cent,” said Tidwell.
Fallen company valuations and operating losses are the main factors that make such a move attractive right now, they say, and making the change could save a company up to half of its current tax bill.
But any company considering such a move has to move quickly. The change must be made within 75 days after the end of a company’s financial year.
The S corporation option is underused, said Tidwell. And while the C and S both offered advantages, changes to the way the C corporation is taxed had taken away many of the deductions it once offered. Now, he said, an S corporation is a primary choice for company owners looking to minimize taxes.
The BIG tax
“The main barrier to switching from C to S corporation is something call the built-in-gains (BIG) tax,” says DeWitt. ” Uncle Sam really doesn’t want to you to reap a windfall by switching. In a nutshell this BIG tax will tax anything you sell in your first few years as an S corporation as if you were still a C corporation. The thing that makes it attractive now is that while values are low on equipment and trucking companies in general, that built in gains tax is going to be as low as it will ever be.
“It’s kind of locking in low value, which in a tax situation is a great thing,” said DeWitt.
“We’re constantly surprised to find that many business owners do not know what sort of corporation they are,” said DeWitt. “That might be why a lot of them haven’t considered changing before. It is challenging to change over, but now is the time to think about it. That’s especially so if you will one day be selling the business. If you don’t, on that sale day you’ll wish you had.
“Many owners don’t know it is an option until they face selling their company and realize how much better off they would have been if they had switched from a C to an S corporation years before,” said DeWitt. “The S is really something everyone should consider as part of their exit strategy. You must plan how you are going to sell, and you must plan it years in advance. If you don’t you are sticking your head in the sand.”
The poor economy and an oversupply of trucks brought the value of rolling stock down, significantly lowered the values of companies, and caused serious operating losses. The valuation of trucking companies has actually fallen more than the stock market itself. If a C corporation were to change to an S in healthy economic times it would first pay a lot of taxes on profits and higher company valuations, said the two, but since many companies don’t have that rosy year-end tax picture this year.
Your company’s year-end tax bill right now will be at a minimum thanks to the economy, said Tidwell.
“Minimizing your income or maximizing your loss is vital if you are going into a conversion,” said Tidwell, “and this year offers you that chance. It can sound scary to consider doing that, but if you involve your banker and your most trusted advisers you can demonstrate that it is not a dangerous thing to do but a very sound basis for beginning a conversion. And if you can tell them ‘I’m doing this to cut my tax bill in half’, they’ll listen.”
De Witt echoes the need for informing the people involved in managing your company’s assets. “If you haven’t warned them, alarm bells can go off when they see the numbers indicating losses and low values.”
But as the economic recovery continues your window of opportunity to switch from C corporation status to an S corporation will get smaller and smaller because a healthier business makes it harder to minimize values and maximize losses, said Tidwell.