Firms Puzzle Over Tax Riddle

Business owners can’t change the tax code, but many of them say they might change the way their businesses are structured in order to pay less tax.

Chris Pullen of Fort Collins, Colo., is grappling with whether to convert his growing business into a so-called C-Corporation, as a potential tax-savings move.

Mr. Pullen, president of 20-employee RLE Technologies, is among the nearly 30 million business owners who include their business profits on their personal income-tax returns. Changing the company to a C-Corporation would let him pay corporate taxes separately from his personal taxes.

RLE, which makes sensors that monitor data centers, hospitals and other facilities for temperature, humidity and water leaks, had more than $5 million in revenue last year. It is structured as an S-Corporation, which means its profits “flow through” to its owners, who pay taxes on that money at personal tax rates.

“The more taxes we pay, the less we have to reinvest,” says the 54-year-old Mr. Pullen, who became a part-owner of the company last year.

He says RLE’s five shareholders generally take $100,000-a-year salaries. But claiming their share of business profits drives their collective taxable income several hundred thousand dollars higher—even though most profits go back into the business to pay for new employees or equipment.

This year personal income-tax rates for the highest earners—single filers exceeding $400,000 and joint filers exceeding $450,000—rose to 39.6% from 35% in 2012. The problem for shareholders of RLE, which has 12% annual revenue growth, is that the business could be bringing in enough profit within a few years to bump them into the highest tax bracket.

The top corporate-tax rate, by contrast, is 35%, though it might decline if Congress overhauls corporate taxes. President Barack Obama called for a cut in business-tax rates in his State of the Union speech last week, and has previously proposed eliminating loopholes and subsidies in order to reduce the highest corporate-tax rate to 28%. Such a move would make switching to a C-Corporation structure “even more appealing,” Mr. Pullen says.

Lowering taxes is a top priority for business owners this year, especially in light of the higher individual tax rates. Tax worries are “right up there with health care, cash-flow concerns, debt obligations and financing” as big problem areas for U.S. small business this year, says Scott Berger, tax principal at the accounting firm Kaufman Rossin in Boca Raton, Fla.

Continue reading this tax article at The Wall Street Journal.