The recently enacted tax law, known as the Tax Cuts and Jobs Act, dramatically lowers the effective income tax rates for most businesses. For businesses operating as regular C corporations the top tax rate has been reduced from 35% to 21%. Also, for pass through entities, such as S corporations or Limited Liability Companies (LLCs), the combination of lower individual tax rates and the new 20% Qualified Business Income deduction could reduce the top federal tax rate on income from those entities from 39.6% to 29.6%.
The news about reduced tax rates has created a predicament for some businesses currently taxed as pass through entities. Since the reduced potential net effective pass through income tax rate of 29.6% is greater than the flat 21% regular corporation tax rate, it appears that switching to C corporation status may be valuable.
There are a few advantages and disadvantages to making the switch from S-corp to C-corp.
More flexible fringe benefit rules for C corporations
Some tax favored fringe benefits, such as employer provided health insurance and cafeteria plan benefits, are limited for a more than 2% owner of a pass-through entity. Regular C corporations do not have these limitations.
Special gain exclusion rules for some C corporations
There is a special benefit for owners of small C corporations to exclude most if not all the gain from the sale of the stock of those corporations.
Deductions like state & local taxes and entertainment
Under the Tax Cuts and Jobs Act the deduction for state and local income taxes is severely limited. These would be fully deductible by a C corporation.
Furthermore, beginning for amounts paid or incurred after December 31, 2017 entertainment expenses are no longer deductible.
C-corporations are still subject to double taxation
One disadvantage to C corps, of course, is that they are subject to two levels of taxation, one at the corporate level on earnings and one at the shareholder level, for example, on dividends.
C corporations face a tax disadvantage when sold
If a company is sold, it is most often structured as an asset sale, which results in two levels of tax for a C-corp – one tax to the corporation when it sells its assets in exchange for cash and a second tax if the corporation is liquidated and the stockholders exchange their shares for the sale proceeds.
The 21% corporate rate could always increase
Although the tax rate reduction to 21% is currently considered to be permanent, based on prior history the only permanent aspect of tax law is change. It is very likely that a different administration could increase the corporate tax rate in the future.
If you, as a business owner, are asking yourself, “Should I switch to a C corp?” note that there is not a one size fits all answer. To discuss why making this change may be beneficial to you, contact us today.
BluePoint Financial, LLC
151 Regions Way, Suite 6B
Destin, FL 32541