If this new tax bill is passed, I’m incorporating…and here’s why you should too.

Man…under the terms of the new GOP tax plan it looks like you could substantially cut your tax bill by using a corporation as a tax shelter. To name just a few ways:

-You could pay only a flat income tax rate of 20% instead of a marginal one that’s as much as 42.3%.

-You could keep your state and local income tax deductions instead of giving them up.

-You could shield your salary from any taxation at all.

-You could set it up so you pass these tax benefits to your heirs; thus never owing any income taxes on the increased value of your corporation within your lifetime.

And more. So let’s discuss these—what the hell, call them “games.”


To get a grip on them let’s review the idea of second-layer taxation. Put simply, it’s that corporate income1 is subject to taxation twice: first when the corporation earns it; then again when the investor receives it and/or sells the equity.

These two layers add up to an effective rate that’s pretty much equal to an individual’s top marginal rate. So when you add to this the expense of incorporating, up until now there’s been little incentive for individuals to form corporations for the purpose of sheltering taxes.

But as I said, under the GOP tax plan all that’s set to change.


This was all brought to my attention by a report entitled “The Games They Will Play: Tax Games, Roadblocks, and Glitches Under the New Legislation”2 which reflects input from a large group of US law and tax experts. I’ll be referring to and quoting from it as “Games.” I may also paraphrase its language for the sake of brevity. All credit to this report; no plagiarism intended.

Also note that a key assumption underlying this report is that:

“[W]e suspect that in the end, the wealthy and well-advised will benefit disproportionately from these errors of sight and haste.”

As much as I’d like for you to be wealthy and well-advised, here’s the usual disclaimer: I AM NOT A LEGAL, TAX, OR FINANCIAL EXPERT.3 This post is not to be construed as advice. I’m simply summarizing a thirty-five page report in order to pique your interest. For the full picture I encourage you to read the original.


OK, it’s been established that both the House and Senate versions of the GOP tax plan incentivize individuals to use corporations as tax shelters by setting preferential corporate tax rates; rates that would fall far below the total of incorporation cost and double-taxation, and in fact as low as 10% on certain kinds of income. This encourages the following games.

Game One: Accrue corporate earnings at the 20% tax instead of distributing them at the “investor’s” marginal rate.

As “Games” points out:

“The simplest strategy is for a taxpayer to invest through a corporation so her investment income accrues at the lower corporate rate.”4

This permits at least two sheltering methods.

First, earnings distributions in the form of fixed-income payments (e.g. bond interest) could pile up in the corporate coffers at the 20% tax rate. This would shield the individual investor from paying her marginal tax rate of as much as 43.4 % on them.

Second, corporations would also receive preferential tax treatment when it comes to capital gains distributions. Dividends, for instance, would be taxed at a much lower rate of 10% since under these bills domestic corporations get a 50% deduction for dividends paid by other domestic corporations. Dividends to individuals, on the other hand, would be taxed at 23.8%.

Game Two: Accrue labor income as corporate profits .

“Taxpayers will relatively easily be able to shield their labor income…[by] having their income accrue in the form of corporate profits. This has the potential to permanently shield labor income from a higher rate…”5 

Simple, really. Again, accrual rather than distribution incurs a lower tax liability.

Game Three: Change salary income into corporate income.

In the same vein, shareholder-employees in a closely-held corporation can choose to take pay cuts, once again accruing income within the corporation to lever lower tax rates and the elimination of double-taxation. This game could also have the effect of lowering the individual’s marginal rate against, for example, dividend income from other corporations.


“Games” further discusses the potential of “super-charging” tax savings when combined with existing second-layer tax avoidance methods. Here are three.

Super-Charge Method One: “…C-corporation stock can be held until death, at which point the second level of tax is entirely wiped out due to ‘step up’ in basis.”6

A refresher: basis step-up is a “death benefit” in which an asset’s cost to an heir is considered to be the market value at the time of its inheritance.

Let’s say that Gramma bought a…oh, why not…Bitcoin for ten bucks several years ago. She dies, leaving that Bitcoin—now valued at $16,000—to little Timmy. Basis step-up means that when little Timmy sells that Bitcoin, the amount of capital gains tax he’ll pay will be based on $16,000 rather than $10, which will obviously save him a large amount of money.

This same avoidance method applies to corporate stock. If Gramma has been sheltering her income by holding an interest in a C corporation, little Timmy can inherit those shares at their current value rather than at Gramma’s original basis. That current value, though, could be substantially higher due to all the income Gramma allowed to build up. No taxes would ever be owed on that income.

Super-Charge Method Two: Transforming salary income into Roth stock holdings completely shields  income from second-layer taxation.

As discussed earlier, a C corporation shareholder-employee can take a cut in pay so corporate profits will accrue at the 20% rate. Since this serves to increase share value and since the shareholder-employee can receive share distributions directly into her Roth account without taxation of future gains in valuation, she’s therefore exempted taxation of future capital gains tax from the sale of those those artificially-inflated shares.7

Super-Charge Method Three: “Even if the corporate interest is not held in a Roth account, the taxpayer may similarly reduce the individual level of tax by waiting until retirement to receive distributions, when the taxpayer may be taxed at lower marginal rates.”8

Self-explanatory.

Now…those three sheltering methods are already available to individual taxpayers  But again, this is a case where at the current level of corporate tax rates there’s very little incentive to engage in these methods, such that lower corporate taxes will clearly result in higher individual incentives to shelter using corporations.


Another reason I encourage you to read “Games” in its entirety is that it gets into ways to fix the current tax plan for the sake of more equitable treatment of corporations and individuals, as well as other reasons.

It also goes in-depth into manipulating pass-through income, restructuring state and local taxes to maintain deductibility, gaming international situations, and setting up arbitrage opportunities based on the end of the old tax code and the beginning of the new. But those discussions assume that the individual definitely is or will be participating in a corporate tax shelter. Since you may or may not do so, I’m reluctant to get into them at this time. Just know that they’re there.


As I said earlier, I’m no law/tax/financial expert. I simply wanted to share this report with you to pique your interest in it.

And with that said, I’d like to ask you to share your thoughts with me. I may have overlooked things; may have made errors or misrepresentations. And maybe you’re further along in your studies than I am. If either are true, please let me know in the comments section. I don’t have any ego in this…my whole objective is learning to optimize my financial situation and sharing that knowledge.

Fire away.

Footnotes

  1. Specifically C corporation income. The term “C corporation” refers to corporations subject to Chapter C of the IRS code. It’s the most common type.
  2. Avi-Yonah, Reuven S. and Batchelder, Lily L. and Fleming, J. Clifton and Gamage, David and Glogower, Ari D. and Hemel, Daniel Jacob and Kamin, David and Kane, Mitchell and Kysar, Rebecca M. and Miller, David S. and Shanske, Darien and Shaviro, Daniel and Viswanathan, Manoj, The Games They Will Play: Tax Games, Roadblocks, and Glitches Under the New Legislation (December 7, 2017). Available here.
  3. I know a little about hammocks and rum, but that’s beside the point.
  4. “Games,” page 7.
  5. “Games,” page 7.
  6. ”Games,” page 8.
  7. Incidentally, during his 2012 presidential campaign Mitt Romney got called out for participating in a variation of this method to the tune of $102 million. He gamed a change in the tax code through a traditional IRA with his Bain Capital equity, but the situation was very similar.
  8. ”Games,” page 8.

Author: ER Dude

Sick of your job? After a thirteen-year career, Early Retirement Dude fled corporate America for good. You can do it too! Visit http://EarlyRetirementDude.com or email EarlyRetirementDude@gmail.com.

10 thoughts

  1. I am a Canadian so I can’t take advantage of these ,but as an investor in US equities I wonder what kind of impact these tax changes will have in the market. Some say the market has already accounted for these and it’s already priced in (maybe part of the reason for the upward swing in the market. )

    Tax laws in Canada are changing too ,but our government is going the opposite direction and placing more restrictions targeting the “unfair” tax advantages used by the wealthiest Canadians.

    1. >as an investor in US equities I wonder what kind of impact these tax changes will have in the market.

      So do I, my friend…so do I. But yeah, 2017’s bull run definitely has the air of celebration.

  2. Nice reply and analysis.

    The one enforcement question will be trading labor for corporate profits. The IRS is already really solid at making S-Corp owners pay themselves a market rate salary for FICA purposes.

    As always, the tax lawyers and accounts will win

  3. A few points:
    -“[W]e suspect that in the end, the wealthy and well-advised will benefit disproportionately” Isn’t this always the case? That’s what wealth and good advice gets you.
    -It’s always interesting to remember that every law and regulation is there to persuade you to do what the government wants. Sure, for some it might seem “their hand is forced”, but it’s their way of nudging you along the path they’d like you to be on.
    -Techwiz: Who knows how the markets will react! The moment we think “Of COURSE it will zig if that event happens!”, it zags.

    1. >Techwiz: Who knows how the markets will react! The moment we think “Of COURSE it will zig if that event happens!”, it zags.

      Always thought of “zig” and “zag” as a false dichotomy. It’s n-dimensional chess, right? When you think the market’s gonna zig, it instead changes its name to “Peter” and moves into an ashram in Madagascar. 🙂

  4. Interesting analysis. I’ve investigated and read similar ideas from different sources. One piece of information that also needs to be considered is FICA. When creating an scorp, for example, the salary taken will have 15.3 percent self employment tax tacked on to that 20%. If your income comes from interest or dividends, how much do you have to make to reach into the 35.3 % range? Provided, dividends and interest remain FICA free.

    1. So many questions about this, yeah. So educational. Regardless of whether the reconciled version actually passes, I still look forward to reading the analyses. Can’t imagine a situation where dividends and interest get FICA tacked on, or at least not under this administration.

      But one never knows. 35’s the marginal rate above ~$425K, so at, say, a 3% dividend yield you’d have to have (hasty math) $14 million in holdings to generate that much? But I think at that point you’d REALLY want to be looking at a C instead of an S.

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