For tax years beginning in 2018 and beyond, the Tax Cuts and Jobs Act (TCJA) created a flat 21% federal income tax rate for C corporations. Under prior law, C corporations were taxed at rates as high as 35% making the C Corporation option less attractive because of a potential, higher tax rate.
On the surface, the change in tax rate to 21% may make choosing C corporation structure seem like a no-brainer, but there are many other considerations involved.
Under prior tax law, conventional wisdom was that most small businesses should be set up as sole proprietorships or pass-through entities to avoid the double taxation of C corporations: as a C corporation pays income tax as an entity and then shareholders pay tax on dividends.
Pass-through entities pay no tax at the entity level and the owners now get a 20% deduction on the income that passes through to them on their personal tax return. The TCJA also reduced individual income tax rates, which apply to sole proprietorships and pass-through entities, including partnerships, S corporations, and, typically, limited liability companies (LLCs).
There’s no one-size-fits-all answer when deciding how to structure a business. The best choice depends on your business’s unique situation and your situation as an owner. Here are three common scenarios and the entity-choice implications:
- Business generates tax losses. For a business that consistently generates losses, there’s no tax advantage to operating as a C corporation. Losses from C corporations can’t be deducted by their owners. A pass-through entity will generally make more sense because losses pass through to the owners’ personal tax returns.
Business distributes all profits to owners. For a profitable business that pays out all income to the owners, operating as a pass-through entity generally will be better if significant QBI deductions are available. If not, it’s probably a toss-up in terms of tax liability.
Business retains all profits to finance growth. For a business that’s profitable but holds on to its profits to fund future growth strategies, operating as a C corporation generally will be advantageous if the corporation is a qualified small business (QSB). Why? A 100% gain exclusion may be available for QSB stock sale gains. If QSB status is unavailable, operating as a C corporation is still probably preferred — unless significant QBI deductions would be available at the owner level.
These are only some of the issues to consider when making the C corporation vs. pass-through entity choice.
This is another Question ForMy Account. If you have a question, are interested in changing your business incorporation, or are looking for business advisory services in Clearwater, Largo, Dunedin, Oldsmar, Lutz or contact BAAP C.P.A. and let us show you the way!
