The new U.S. tax legislation offers a sweet deal for C corporations, which can make giving up your passthrough status an attractive option. If an individual conducts business through a C-corp, then they are entitled to a permanent reduction in the general corporate rate to 21 percent – although there is still a second level of tax applicable on dividend distributions from the corporation.
Taking a step back, if business is alternatively conducted through a passthrough entity – like a partnership or S corporation – then there is generally only one level of tax. Additionally, for tax years after 2017, some taxpayers are eligible for the new section 199A, which offers a potential 20% deduction to sole proprietors or owners of a passthrough business.
If your trade or business qualifies, 199A could provide a significant benefit; but not every business is eligible. And, absent legislation to the contrary, the 199A benefit is only temporary and will not be available after 2025.
MAKING THE DECISION TO SWITCH
As a byproduct of the sweeping changes to the tax law, many private company owners and investors have begun asking themselves whether it is in their best financial interests for their businesses to be structured as C corporations rather than as passthrough entities.
Determining the right answer isn’t exactly straightforward. It requires looking beyond just financial models and base rates and instead considering how the ripple effects of the new and interrelated provisions – which may not be immediately obvious – could impact the future strategy of the business.
It also requires an understanding of both present and expected future business activity, as well as putting some thought into how stable you think the current tax provisions may be. Because, after all, future legislation could be enacted to change the current tax rules.
WORKING AGAINST THE CLOCK
Although the benefits of the new tax code are already available, many of them – like the ones under section 199A – are due to expire after 2025, unless Congress extends it. This means there is a limited amount of time left to take advantage of these benefits, and decisions need to be made quickly.
ARE YOU ELIGIBLE FOR THE NEW TAX BENEFITS?
The 20 percent tax deduction is not available to taxpayers who operate within a specified list of “bad” service businesses. If your business is primarily involved in one of the service areas listed below, there’s a good chance your income may not be eligible:
- Actuarial science
- Performing arts
- Financial services
- Brokerage services
- Investing and investment management
- Certain trading and dealing
- Any other business where the principal asset is the skill or reputation of one or more employee/owner
QUESTIONS TO CONSIDER
When considering whether a switch to C-corp status makes sense for your business, there are many factors to consider. But as a starting point, the following questions should be part of the discussion you have with your executive team and tax professionals:
- Is the trade or business expected to generate income or loss in the foreseeable future?
- Is any of your trade or business able to benefit from the 20 percent deduction?
- Is there a tax cost of getting into a C corporation?
- What is the anticipated exit strategy for the business?
- Will cash be retained or distributed by the business?
- Is there a state tax deduction that would be available for a C corporation but not for an individual?
- Is there a state tax difference between being classified as a passthrough and a C corporation?
- Are there any international considerations?
- How sensitive is the decision to tax law changes in the future, such as an increase in the corporate tax rate?
- Are there any “nontax” drivers to the decision, such as complexity of reporting, or investor attractiveness?
ABOUT CAROPRESE & COMPANY
Caroprese & Company is a certified public accounting firm that provides innovative and strategic services to a diverse client base of individuals, families, small and medium size businesses, government entities, non-profits and multi-national corporations. Our dynamic professionals perform at a high intensity and are laser focused on providing excellence to our global clientele.
CONTACTING CAROPRESE & COMPANY
This publication is provided by Caroprese & Company as a service to its clients and colleagues. The information and content included in this publication should not be construed as technical advice. Questions regarding any matters discussed in this publication should be directed to Brandon Caroprese whose contact information is listed below:
Brandon Caroprese, CPA, MST