Whether it is nobler in the mind to suffer the higher effective tax rates as a flow-through entity, while maintaining optimum future planning flexibility, or elect to convert your flow-through entity to be taxed as a C corporation, and by doing so realize the immediate and delicious 21% “permanent” C corporation tax rate?
It seems like a simple question. It is not.
Tax Cuts and Jobs Act Impacts
The Tax Cuts and Jobs Act (TCJA) has brought many changes for business owners to consider. None more important or daunting than their entity choice. Under prior law, the conventional wisdom was that most closely-held businesses should be set up as a pass-through entity to avoid the double taxation of C corporations.
Conventional wisdom no longer applies.
In addition, the number of underlying questions and/or assumptions that must be addressed in order for a flow-through business owner to make an informed analysis and ultimately a decision on whether to make a change to a C corporation can be exhausting:
- 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?
- How does the decision impact 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?
- What about 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?
- Will the Republicans or Democrats control the U.S. House and Senate?
Furthermore, the facts and/or assumptions are subject to immediate change; which may be why so many taxpayers and/or their practitioners have taken a “head in the sand” approach. However, do so and you may suffer the slings and arrows of unintended additional taxes.
Key Considerations
We have found the process becomes easier once you address the core assumptions and begin to tailor the analysis to a particular situation. In addition, we recommend that the selection of entity choice be reviewed/modeled annually.
Finally, some items to consider/note regarding any potential change in how you may be taxed:
- LLC’s can elect to be taxed as a C corporation.
- S corporation can revoke the S election by filing a statement of revocation with the IRS.
- There is a five (5) year waiting period before a former S corporation and re-elect S status.
- There is a five (5) year built-in-gain (BIG) waiting period, after Selection, to avoid corporate gain on sale of assets.
Clayton & McKervey can help by walking you through the assumptions, prepare a modeling analysis, assist in interpreting the results and help you make the right decision. Contact us today to learn more.
