Big Implications In Dividend Proposal

March 14, 2003
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Entrepreneurs and business owners may do better for themselves forming or restructuring their company as a C corporation under President George Bush’s proposal to eliminate taxes on dividends.

The plan, as proposed earlier this year, would make life more costly for some closely held businesses structured as limited liability companies (LLC) or S corporations.

Anthony Ilardi Jr. says that’s because the proposal would make the earnings of such corporations taxable.

Ilardi is a partner and tax expert with the law firm Dykema Gossett PLLC, which has an office in Grand Rapids.

He explained that as Congress considers the proposal, business owners should start thinking about whether LLC and S corporations are “still the best choice” and how they may react if the president’s proposal earns adoption.

“It has a huge effect, especially for the closely held businesses,” Ilardi said.

“For some people it’s not going to make a lot of difference, and for some people it’s going to make a lot of difference.”

Under an S corporation or limited liability structure, he explained, businesses don’t pay income taxes. Instead, the government derives its revenues from taxes upon the income that those companies’ owners and shareholders receive.

Ilardi explained that President Bush’s proposal would change the tax benefits of an S corporation or LLC structure.

He said the proposal would tax all corporate earnings, but then exclude from taxation the after-tax profits that would be distributed to owners and shareholders in the form of dividends.

Until the president’s plan was unveiled, C corporations were not considered an attractive corporate structure for small and closely held businesses because they have a greater tax burden, Ilardi said.

The earnings of C corporations are now taxed at the corporate level and then again once they are distributed as dividends to owners and shareholders.

Ilardi’s advice for the owners of companies that are structured as an S corporation or LLC is to start talking to their tax adviser, understand the ramifications of the proposal for their business, and prepare themselves to make a change quickly should the president’s plan pass.

Switching to a C corporation would make sense for some business owners, Ilardi said, because of the lower top tax rate for corporations of 35 percent, compared to the 38 percent top tax rate for individuals, Ilardi said.

Moreover, beyond certain personal income thresholds, effective tax rates rise to slightly above the 50 percent level because mortgage and property and state and local income tax no longer count as full deductions from one’s gross income.

Entrepreneurs preparing to form a business need to keep the closest watch on the proposal, he said.

“With this kind of legislation pending, it may be kind of time sensitive.

“You don’t want to structure a transaction that won’t work very well if this proposal is adopted,” Ilardi said. “All of this depends on what comes out of the sausage maker in Congress.”

He believes that given the weakness in the economy, Congress will enact tax relief this year.

“We will see some kind of tax legislation,” Ilardi said.

Under President Bush’s proposal, some industries will not benefit.

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