In the months after the recent Tax Cuts and Jobs Act was signed into law, we’ve received many questions from business owners regarding the new 21 percent corporate tax rate and if it applies to them. In almost every case, the response is no because they either were a partnership, S corporation, or a disregarded entity for tax purposes. In all three of those entity structures, the income passes through to the individual owners and is taxed on their individual tax return.
The long-time benefit to these pass-through entity structures is avoiding the double tax hit of being a C corporation where the earnings would be taxed at the entity level, and then taxed again when distributed to the individual owners as a dividend. Under the new tax act however, the C corp tax rate dropped from a top 35% tax rate down to 21% and with a top 37% individual tax rate it now brings up the question is now the right time to make the conversion to a C corp?
There is no one simple answer to this question as it involves taking into account many considerations.
- Does the company consistently distribute its earnings?
- What line of business is the entity in?
- What tax bracket is the owner in?
The list goes on, and of course there is also the five year rule to consider, where you generally are not able to revert back to an s corporation after switching to a c-corporation.
In addition to considering the new low corporate tax rate, there were also some added benefits the tax act added for pass-through entities. For example, the 20% deduction of “qualified” business income was created and even with its limitations, has proven to be a good benefit in many of our 2018 tax planning scenarios.
If you are considering making a change, or if you would like us to run the numbers, please reach out to our tax department. We can complete an S vs C comparisons specifically for your situation.