April 2018

Navigating Business Tax Classifications in 2018

The Tax Cuts and Jobs Act of 2017 (the "Act") has dramatically changed the tax landscape this year. Two important changes include the new 20% deduction for pass-through entities, such as S-corporations and partnerships, and the 21% flat tax rate for C-corporations. Where conventional wisdom once dictated that most small business owners elect S-corporation tax status for their companies (a "pass-through" option), these new rules should have owners re-considering whether C-corporation tax status might offer better tax results

In this article, we will compare S-corporation (pass-through taxation) and C-corporation (corporate taxation) tax classifications for business owners at two different income levels. One example covers an owner with taxable income just below the $315,000 taxable income phase-out threshold for married filing jointly status ("Income Level I") and one shows an owner with total income of $1 Million ("Income Level II") when factoring in both her personal income (from W-2 wages) and business net income. The detailed examples can be found here.

As for our conclusions, at incomes around Income Level I, there is an advantage to using pass-through taxation because much of the income is taxed on the individual's return at rates below the 21% rate applicable to C-corporations. However, at higher personal income levels, such as Income Level II, if there is a desire to re-invest significant funds in the business, using C-corporation taxation may enable a business owner to pay lower income taxes and therefore have more funds for business growth.

Should you choose S-corporation or C-corporation income tax classification? As with many tax questions, the answer ultimately is: it depends. Specifically, the owner's goals for the business profits should be a driving force in determining the appropriate tax classification in each situation. Pass-through entities expose business income to individual brackets which include rates below 21%. If this amounts to a major portion of the income, it can be a very important factor and favors pass-through entities such as S-corporations and partnerships. As personal incomes increase, more individual income will be exposed to brackets above 21% and, if the intention is to leave it in the corporation anyway, then the C-corporation classification can result in lower income taxation. Business owners should consult with their CPAs, attorneys, and financial advisors to take full advantage of these new tax laws.