Should My Agency Be an S Corp or a C Corp?

November 12, 2019

Recently I spoke at the Independent Insurance Agents (IIA) of Illinois annual conference on financial planning for agency owners. After the presentation which included a discussion on taxes, an owner approached me about the tax structure of his agency. He is currently structured as a C Corporation and wanted to know if that was the most tax-efficient structure. My answer was simple: it depends.

There are pros and cons to being structured as a pass-through entity (S Corp, Sole Proprietor, LLC) just as there are pros and cons to a C Corp. One major difference is the taxation of profits. Pass-throughs are generally taxed at individual income tax rates while owners of C Corps are subject to double taxation of profits. They are taxed at the corporate tax rate in the year of the profit and taxed again as dividend income on the individual tax return at the time of the distribution.

Distributions – How are they handled?

With the recent Tax Act of 2017, a C Corp tax rate dropped from 35% to 21% and pass-through entities (S Corp, Sole Proprietor, LLC) are now eligible for a tax deduction of up to 20% on “qualified business income.” This reduces the top effective tax rate from 37% to 29% for pass-through entities. For those individuals in the 24% tax bracket (married couple with income between $165,001 and $315,000) it can be reduced as low as 19% and taxed only once.  Therefore, one of the driving factors from an income tax perspective is how much cash your agency is generating and how much of that is being distributed to owners. If you are generating a significant income but reinvesting in the business, the C Corp might make the most sense. If you are distributing most of the income as a pass-through structure could make the most sense from a tax perspective.

What do buyers want?

When do you plan on selling the agency? When setting up your agency you probably didn’t put much thought into how your structure would impact the sale of your agency. Buyers of insurance agencies insist on purchasing the assets of the business rather than the business so they can amortize purchase over 15 years and limit any unknown liabilities that might have existed in your agency. This creates a challenge for C Corps because it can result in double taxation at the sale and can make pass-throughs more attractive when selling an agency.

Asset Protection

Although not tax-related, an advantage of a C Corp is the asset protection it provides shareholders. If operating under a sole proprietor, partnership or S Corp, the owner has unlimited liability for any business obligation which could unknowingly expose personal assets. Agency owners who are pass-through entities should consider forming a Limited Liability Company (LLC) to limit the agency owner’s personal liability. The LLC can be treated as a disregarded entity for federal income tax purposes which means that the income will flow onto each member’s individual tax return and will provide a layer of asset protection to the owner.

The answer as to what structure makes the most sense for your agency truly does depend on many variables. Understand your agency’s income, typical distributions, and liability exposure to help determine what structure makes most sense for you. Most importantly consult with your tax preparer to truly understand the tax impact of your structure.

BDF’s Commercial Insurance Practice Group understands equity compensation and the valuation of a business and uses this knowledge to help insurance professionals develop financial plans while minimizing tax bills. Whether working with a producer or business owner, we focus on one’s individual goals, family involvement and living a full life.

Jim King, CPA, CFP® is an owner and wealth manager at BDF where he leads the Commercial Insurance Professionals Practice Group. He uses his understanding of the insurance industry to help insurance professionals maximize their prime earning years, develop a discipline around saving those earnings and put a plan in place to best utilize assets. His focus on creating financial blueprints for his clients has earned him recognition as a “Five Star Wealth Manager” by Chicago Magazine.