By: Steve Drake, PhD, CPA, CFP®, CGMA
There may be nothing more important to save tax and to improve your financial plan then to decide on the right operating entity. Please refer to the “Choice of Operating Entity” Comparison Chart on a related article on this website.
Included in this article is an executive summary of effective tax rates by type of entity. In short, S Corporations are taxed the highest (almost 32%) followed by certain types of partnerships (29%). The lowest taxes are being paid by C Corporations (18%) and individuals (15%).
In the corporate calculation summary, this would include the largest of US corporations that would tend to drive up the overall rates while with individuals, because of the large number of filers, that this would understate this category. Bottom-line, C Corporations in combination with individuals, have plenty going for them in income and estate planning to minimize their effective tax brackets.
In order to maximize the intangible drilling cost deduction then it may be necessary to start operations as a joint venture, general partnership or as an individual. This is necessary so that liability for tax purposes will not be limited. This is for technical IRS reasons. This may limit the initial use of S Corporations, limited liability companies and limited partnerships to the extent there are investors involved. Later, the structure can be changed to another type of entity such as a C Corporation or LLC. However, there are ways to involve a C corporation or another entity from the beginning to mitigate taxes and provide some liability protection. This will largely depend on the circumstances of the operation, outside investors or not and the legalities of each situation.
With royalty situations, a lot of this structuring can be much more straightforward to maximize the financial and tax benefits to achieve the lowest possible tax.