C or S Corporation and the 3.8% NIIT

Posted by Lee Reams Sr. on

One of the factors to consider in regards to deciding to do business as a C Corporation or utilize the Sub S election (where there are 100 stockholders or less) is the 3.8% net investment income tax.  If you are the owner of an S corp. and you are active in your business, and you sell the stock in your business at a gain, you eliminate the requirement to pay the 3.8% Medicare surtax on the gain, which can be a serious sum of money. If the business is currently a C Corp, one possibility would be to switch to an S Corp status prior to the sale, keeping in mind that the election must be made within the first 2 months and 15 days of the corporation’s tax year for the election to apply to that year.

On the other side of the coin, if President Trump has his way, the tax rate for C Corporations will drop to 15% and the top tax bracket for pass-through entities such as partnerships and sole proprietorships would also be 15%.  Although thought of as a pass-through entity, it would seem an S Corporation would not benefit since active owners of S Corporations must take a reasonable salary which would be subject to the individual graduated rates, currently proposed to be up to 35%, and any K-1 distribution would be treated as investment income also subject to the graduated rates plus the 3.8% NIIT. 

Of course, this entire issue may disappear if the 3.8% NIIT is repealed as part of either health care or tax law reform.