WARNING this is a technical post. The question that has been circling around the CPA water cooler for almost the last year is “Given the change to the corporate income tax rates under the Tax Cuts & Jobs Act of 2017 (“TCJA”), should I switch to a C Corporation?”
The canned answer is “it depends…”
To give you a bit of background without putting you to sleep – under the TCJA, the corporate tax rate starting in 2018 has been lowered to a flat 21% from progressive 35%. This is huge since certain professions get labeled as a Personal Service Corporations (PSC) was a flat 35% regardless of income. The top individual tax rate starting in 2018 is 37%. That means, if you have a substantial income, when the S Corporation ordinary income is put into your return you would pay 37% since tax on S Corporation income is paid at the individual level. Still with me? Good. Its about to get more technical.
Another hallmark of the TCJA is the 20% Qualified Business Income (QBI) deduction. This deduction is available for businesses that are considered Pass-Through Entities (Partnerships, S Corporation, LLC, Sole Proprietor, et. al.) and caps the highest effective individual rate on qualified business income to 29.6%. So, in short 21% is less than 29.6% so we should all be C Corps. Not so fast! C Corporations do have a flat 21% federal income tax rate, but one of the long standing critiques of US Corporate Tax Law is the fact C Corporations are subject to DOUBLE taxation. Simply stated, you pay tax on the corporate net income and you pay tax on the dividends you receive from a corporation.
To illustrate, assume you have $1,000 of corporate income. After taxes, you would have an after-tax net income of $790. Then assume you paid a $790 dividend to yourself. If you assume a 20% rate on dividends after taxes you’d net $632. So you made $1,000 and walk home with $632. That is $368 in taxes or 36.8% so now 29.6% is less than 36.8%. So, what does this all mean? The first thing is, if your current adviser isn’t talking to you about this kind of stuff, they are doing you a great disservice. Secondly, you never do anything SOLELY for tax savings.
Lastly, tax is a complicated matter and you need someone you trust to walk through this type of analysis with you. Camelback Advisory + Consulting, Inc would be honored to walk through these kind of scenarios with you.
This blog is purely for informational purposes. In no way is this blog meant to be taken as tax advice as any change in facts or circumstance could change the advise given.