To ‘C or not to C’—that is the question for many business owners—whether ’tis nobler to organize as a flow-through entity with future planning flexibility or convert to a C corporation with a better tax rate. The decision may be tougher than first thought, according to Jim Biehl, a CPA, and shareholder at Clayton & McKervey, a certified public accounting and business advisory firm helping growth-driven companies compete in the global marketplace because many organizations are still grappling with Tax Cuts and Jobs Act (TCJA) changes that have made entity choice a more involved process.
“Before the Tax Cuts and Jobs Act, most closely-held businesses were set up as flow-through entities to avoid the double taxation of C corporations, but now many are thinking of converting because they don’t want to pass up the enticing 21% ‘permanent’ C corporation tax rate,” Biehl said. “What used to be simple is not so straightforward, and may explain why so many companies are opting for a ‘head-in-the-sand’ approach instead.”
Unfortunately, avoiding the inevitable can lead to unintended additional taxes, Biehl said. The number of underlying questions flow-through business owners must address in deciding whether to make the change to a C corporation may seem daunting, but is imperative in helping to make this determination:
- What is my taxable income outlook?
- What is the nature and timing of my anticipated capital investments and related bonus deprecation?
- How much money do I want to pull from the business?
- Is my compensation reasonable?
- Impact on foreign income?
- Do I qualify for the flow-through qualified business income (QBI) deduction?
- Is the flat 21% C corporation tax rate really permanent?
- Will the reduced individual tax rates and flow-through QBI deduction be extended beyond 2025?
- The impact on my Research & Experimentation credits?
- How many states do I file in?
- Does the U.S. Supreme Court “Wayfair” decision impact my state tax filings?
- How do I plan on exiting/selling my business?
- What is included in my estate plan and could I implement a GRAT or IDIT?
- Who will be elected President in 2020?
- Which political party will control the U.S. House and the Senate?
To simplify this process, Biehl suggested a.) prioritizing the four most important questions/assumptions for that business and then modeling the analysis to each particular situation; b.) remembering to review and/or model on an annual basis to address changing needs; and c.) figuring out how the potential change will affect the company’s tax situation, taking into account these four considerations:
- LLC’s can elect to be taxed as a C corporation.
- S corporations can revoke the S election by filing a statement of revocation with the IRS.
- There is a five-year waiting period before a former S corporation can re-elect S status.
- There is a five-year built-in-gain (BIG) waiting period, after S election, to avoid corporate gain on sale of assets.
“Walking through the assumptions, preparing a modeling analysis and then interpreting the results will help companies decide what makes the most sense for their organization—whether that is staying as a flow-through entity or converting to a C corp,” Biehl said.