With Tax Day just around the corner, the 2017 Tax Act may be on your mind. If you’re a business owner, it’s a good time to consider whether restructuring your business could produce tax savings.
Under the new Tax Act, most businesses will experience savings without making any changes, but there may be opportunity for additional savings if you look into restructuring. The case for using a C Corp has not been stronger for decades, and tax rates on “flow-through” entities are also at a record low.
In this post and the next, we’ll discuss how C Corps and flow-through entities are taxed under the 2017 Act, and how restructuring your business could result in savings.
First let’s look at a few of the major changes in the ways C Corps and so-called “Flow-Through” entities are taxed under the 2017 Act.
Reductions in corporate tax rates under the 2017 Act make C Corps competitive again.
- C Corp tax rates were reduced from 35% to 21%.
- Qualifying dividends continue to be taxed at 20%.
- When we combine those two rates (first the 21% on corporate earnings followed by the 20% rate on dividends), we get an effective rate for owners of C Corps equal to 36.8%.
- This effective top rate of 36.8% on C Corps is starting to look competitive in comparison to the new 37% top rate on personal income which is paid by owners of certain flow-through entities.
There is good news for “flow-through” entities as well (including LLCs, Partnerships and S-Corps) which are also benefiting from a significant reduction in tax rates in many circumstances.
- Flow-through entities are entitled to a 20% deduction on so-called “Qualified Business Income” (QBI).
- Assuming an individual taxpayer is at the top individual rate of 37%, this 20% deduction reduces the maximum effective rate on flow-through entities to 29.6%.
- However, the benefit of this 20% deduction is limited and phased out for many professional businesses (accountants, financial advisers, lawyers, etc.) as well as other service businesses which depend on a person’s “reputation.” For those businesses, the deduction is phased out for taxable income between $157,000 and $207,000 (for individuals) and for taxable income between $317,000 and $415,000 for married couples filing jointly.
These are the basic changes to keep in mind when considering next steps for your business this year. Stay tuned for our next post, where we’ll discuss specific strategies to benefit your business under the 2017 Act.