Taxes… Taxes… Taxes are at the forefront of our conversation. Are you a winner or a loser under the new paradigm? How do you better your positioning; change your business structure, your estate planning? Businesses and corporations are clearly winners under the Tax Cuts and Jobs Act (Tax Cuts Act).
Businesses Preferred. Our country’s federal tax structure was inverted by the Tax Cuts Act – – corporations and pass-through entities (subchapter S corporations, partnerships, and sole proprietorships) were given lower tax rates than individuals, making corporations and business entities attractive as tax saving vehicles. And with pass-through entities, those tax savings can increase with a 20% Qualified Business Income Deduction (QBID).
Working Through the Complexities. The Tax Cuts Act is complex for businesses; many of the fine points will need to be clarified and defined over the next months and years through regulations and court decisions. Attorneys and accountants like to “get into the weeds” for the finer points. For a business person, with just a few understandings, you should be able to make decisions for your business.
- The overall advantages of a corporation, whether it has a C or S tax status, generally outweigh a sole proprietorship or partnership, considering taxes, liability risks, asset protection, governance, etc.
- C corporation tax rate is a flat 21%. This usually applies to major companies.
- C corporations are subject to tax at the corporate level on corporate profits and their shareholders are also taxed at the individual taxpayer level on dividends and distributions – this is sometimes referred to as “double taxation”.
- Pass-through entities such as S corporations, partnerships, etc. do not have a federal corporate level tax. Profits fall through the company tax free and those profits are taxed to the individual shareholders, at rates under the Tax Cuts Act that are now higher than the regular C corporation tax rate of 21%.
- To even the playing field under the new Act, pass-throughs (S corporations, partnerships, sole proprietorships, shareholders/members) receive a 20% QBID if certain tests are met, thereby aligning their rate with the C corporation tax rate of 21%.
Medium and Small Business Strategies. Most small to medium size businesses along our Central Coast are “S” corporations because of the current and continuing tax advantage. These businesses should continue as “S” corporations and qualify for the 20% Qualified Business Income Deduction. The “C” corporation structure is generally reserved for large corporations and publicly traded companies. This tax structure is not necessarily an advantage for our area’s small and medium size businesses.
20% QBID. This new deduction is gained by pass-through entities including sole proprietorship, if:
- They are not a disqualified business service business, such as accounting, law, consulting athletics, brokerage, etc. If you are a wholesaler or retailer, the deduction should be available.
- The deduction does not exceed the greater of
- 50% of W-2 wages paid by the qualified business, or
- 25% of wages paid plus 2.5% of the unadjusted basis of your business’s tangible depreciable assets.
There are many, many details and qualifications. Please be sure to run budgets, probable 2018 financials and a tax analysis at the beginning of the year to see whether changes are necessary. Consult with your attorney or accountant to determine what you might do to better qualify for the QBID. If you simply stay the course as a pass-through entity without qualifying for the QBID, you are just taxed at the individual taxpayer rates, as you are now. Qualification for the QBID can give you an additional deduction and lower taxes.
DISCLAIMER: This Advisor is one of a series of business, real estate, employment, estate planning and tax bulletins prepared by the attorneys at Fauver, Large, Archbald & Spray, LLP. This Advisor is not exhaustive, nor is it legal advice. You should discuss your particular situation with us or with your own attorney. Our legal representation is only undertaken through a written engagement letter and not by the distribution or use of this Advisor.
 The Act is 503 pages long.
 At the Federal level, California imposes a 1.5% tax on S corporation profits
 As a business grows, capital, investors arrive, etc. an “S” corporation can easily convert to a “C” corporation and/or a Delaware corporation. See our Business Advisor “Delaware Corporations Not the Best for California Startups”, Business Advisory No. 6.