By now, you know all about the new corporate tax rate — a flat rate of 21% vs. the previous top tax rate of 35% — arguably the most publicized change of the recently passed Tax Cuts and Jobs Act (TCJA).
Other TCJA changes impacting businesses include:
• A potential 20% reduction of taxable income for pass-through entities
• Repeal of the corporate alternative minimum tax
• Enhanced options for expensing new assets
• A new restrictive limitation on deducting interest expense
• Elimination of the favorable Domestic Production Activities Deduction (DPAD) for manufacturers
So if you’re an S corporation or other pass-through entity, restructuring as a C corporation is a no-brainer, right? The answer is: it depends. When it comes to business structures, one size does not fit all. The decision to reorganize should only be made after carefully considering your options, including what makes most business sense for your organization—now, and in the future.
Meet C-inderella Corp., a niche footwear manufacturer specializing in one-of-a-kind glass slippers.
Currently structured as a C corporation, the reduction in their corporate tax rate to 21% is very favorable. However, their owners are nearing retirement and may want to sell the company in the next few years. As a C corporation, any taxable gain on assets resulting from the sale could be subject to double taxation—but not if they restructure as an S corporation, or if the company is located in a tax-exempt state like New Hampshire. Knowing this, C-inderella Corp.’s owners should plan ahead and consider the various tax consequences of being a C corporation or S corporation at the time of sale.
Now consider S-now White Corp., a designer of custom-made, rustic-themed sleep systems.
Currently structured as an S corporation, the potential 20% reduction in their pass-through taxable income is also very favorable. However, their owners have accumulated a fair amount of debt which they’d like to pay down, and are also attempting to accumulate capital for future growth. While restructuring as a C corporation means a lower corporate tax rate, it also means S-now White Corp. is now subject to additional federal taxation on any cash distributions made to their shareholders. Their owners will want to weigh the pros and cons of being a C Corporation or S Corporation under those circumstances, and which results in the highest after-tax cash flow.
The takeaway? No two businesses are exactly alike, and deciding on the most favorable entity type requires careful consideration on a case-by-case basis. Nonetheless, there are some questions every company can benefit from asking themselves, including:
What are your current and long-term business objectives?
With great earnings comes great responsibility—what will you do with them? Depending on your short- and long-term business objectives, you’ll need to prioritize reinvestment against issuing dividends, and each has major implications when it comes to optimizing your tax structure.
What is the current tax situation of your business owners?
A business is only as good as its owners—and their tax rate. Even if the new corporate rate is ideal for your business, the individual rate of your owners and their family members can make a big difference in your ultimate tax liability, especially if you’re dividend-minded.
Which states do you operate in?
If your business operates in multiple states, you’re also subject to those states’ respective tax laws—which aren’t always the same. From residency issues and income apportionment to tax rates and more, state tax laws can vary widely, adding extra layers to your tax landscape.
What’s more, with a five-year waiting period on restructuring again, the sooner you can ask—and answer—these questions, the sooner you can plan around them. A thorough analysis at both the entity and individual level can help avoid surprises, mitigate risk, and identify valuable tax savings opportunities.
Whether you choose to restructure or not, enlisting the guidance of a qualified advisor can help take the guesswork out of evaluating your options — giving you peace of mind that you’re taking advantage of the entity type that makes the most sense for your business.