Suppose you start a new business in the last two months of the year and it is a C corporation. The good news is that if you sell the stock in that business down the road you will not owe capital gains taxes. In the meantime, however, profits of the business will pay corporate level taxes and when you pay yourself dividends, they will be taxed at very high rates. If you “zero out” the income of the business by paying yourself a huge bonus, the IRS can come in and call that bonus a disguised dividend and hit you and the corporation with taxes and penalties (if that bonus is deemed to be excessive compensation (which we’ll examine down the road). So, while you are being offered a potentially huge benefit by excluding capital gains, you will be paying for it in the meantime. Had you instead chose an S Corporation or an LLC you would avoid the corporate level tax and would avoid the excessive compensation issues since those are flow through entities.
So, you have to run the numbers and see whether its worthwhile to do this. Also, if you have an LLC which might be sold in five years, this might be a time to convert it to a C Corporation, but you’d need to review the issues involving excessive compensation before you make that choice. We’ll next discuss the concept of alternative minimum taxes.