Under the 2017 Tax Cuts and Jobs Act, “regular” corporations (also known as C-corporations) will see a dramatic change in their Federal tax rates. C-corporations with less than $50,000 of taxable income will see a tax increase from 15% to 21%. Federal tax rates for C-corporations with taxable income in excess of $50,000 will now be taxed at a flat rate of 21% on their entire taxable income, starting in 2018. This is reduced from graduated tax rates of 25% – 35% on taxable income in excess of $50,000. Most small businesses are typically not C-corporations; they are formed as sole proprietorships, partnerships, or S corporations (also known as pass-through entities), as the income from the entity “passes through” to the individual owner and is taxed at the individual owner’s tax rate. Small business owners are now inquiring about whether they should change their pass-through entity into a C-corporation, as a result in the new 21% flat corporation tax rate.
The 2017 Tax Act is quite complex, and needs to be looked at carefully. First of all, the top individual tax rate has been reduced from 39.6% to 37%. Secondly and more important, most pass-through entities are entitled to a new 20% deduction on “qualified business income” from pass-through entities. This will reduce the effective top individual tax rate from 37% to 29.6%. There are limitations on this deduction for high income individuals. Consideration must be given to the business owner’s intent on receiving distributions of income out of the business. Owners of C-corporations will have to pay tax at their individual tax rate, in addition to the tax that was already paid by the corporation. Where as distributions from a pass-through entity to an owner are only taxes once.
With the many complexities of the 2017 Tax Cut and Jobs Act, you will need professional advice as to the proper choice of business entity for 2018 and beyond. If you have any questions, please contact us.
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