Published by AE Tax Advisors Team • 2025-10-18

S-Corp to C-Corp Conversion Saves Tech Company $95,000 Annually

The Client

NovaTech Solutions, a software development firm in Austin, Texas, was structured as an S-Corporation with two equal shareholders. The company generated $1.2 million in annual net income, flowing $600,000 to each shareholder's personal return. Both shareholders had additional income from investments, pushing them into the 37% federal bracket.

The Problem

As an S-Corp, all $1.2 million in profit passed through to the shareholders' personal returns, taxed at their marginal rate of 37%. The QBI deduction was phased out due to their income level. Combined federal tax on the business income exceeded $380,000 per year.

Our Strategy

We analyzed the impact of converting to C-Corporation status to take advantage of the flat 21% corporate tax rate. After modeling retained earnings, dividend timing, and the shareholders' personal income mix, we determined that retaining $800,000 annually in the C-Corp (taxed at 21%) while distributing $400,000 as qualified dividends (taxed at 20% plus 3.8% NIIT) would produce significant savings. We also implemented an accountable plan for business expenses and optimized officer compensation.

The Results

The C-Corp structure reduced the effective tax rate on retained earnings from 37% to 21%, saving $128,000 on the retained portion. After accounting for the double-taxation impact on distributed amounts, net annual savings reached $95,000. The retained earnings also funded a new product line without requiring outside financing.

Key Takeaway

High-income S-Corp shareholders whose income exceeds the QBI deduction threshold should model the C-Corp alternative. When the business retains significant earnings for growth, the 21% flat rate can dramatically outperform pass-through taxation at the 37% bracket.