Choosing the best type of entity structure for your business has always been a complicated process. There are so many factors that go into making this decision – number of owners, state law, and taxation of the business and its owners to name a few. With the recent passage of Tax Reform, taxation has been brought to the forefront in making and rethinking this decision.
Muddying the Waters in Entity Selection
Businesses have the option to be taxed as C-corporations, S-corporations, partnerships, and sole proprietors.
CRInsight: Reference our Start-up Business Guide for items to consider when evaluating your proper structure.
The Tax Reform has made some sweeping changes regarding how these business entities and their owners are taxed.
Historically, C-corporations had two layers of tax – the corporate tax rate of 35% plus a potential dividend tax rate of 23.8% when the corporation distributed money to its shareholders. That double taxation meant that the top marginal rate in a C-corporation structure may be 50.47%. Tax Reform lowered the corporate tax rate to 21% (down from 35%) beginning in 2018. While the tax rate on corporate dividends remains at the 23.8%, that lowering of the corporate income tax rate means that the top marginal rate becomes 39.8%.
The new Tax Reform also provides a 20% deduction allowed for certain pass-through entities (such as S-corporations and partnerships) and sole proprietors engaged in qualified activities. The top individual tax rate was also lowered from 39.6% down to 37%. When you combine these factors along with the single layer of taxation, the top marginal tax rate for folks that are able to take advantage of these tax reform measures will be 30.7% – 32.6%.
Finding Clearer Answers in the Middle of Many Factors
As there is no clear cut answer to which structure is ideal for all taxpayers, a full analysis of your business and goals is needed to ensure your tax structure selection results in your intended consequences. Some considerations are:
- Are you in the start-up phase and wish to deduct losses against other personal income?
- Does your business qualify for the 20% pass-through deduction?
- What’s your exit strategy, and what is the timeline for that?
These are just a few of the factors that will impact your overall tax efficiency with the tax structure you choose. For a comparison of the tax attributes of the various different entity structures, click here.
Sail through Unclouded Waters with CRI
The Tax Reform has made the corporate tax structure more appealing to some businesses, but it might not be the right fit for every business. Alternatively, the pass-through deduction offers lower marginal tax rates for certain partnerships, S-corporations, and sole proprietors. Meanwhile, there may be some non-tax implications of various legal entities. Contact the CRI tax team, who can help you think through the pluses and minuses of your structure.