Like any business owner, you’re always looking for ways to cut costs and increase the bottom line. With the passing of the 2017 Tax Cuts and Jobs Act, now is the time to revisit the advantages and disadvantages for each tax entity. From differences in tax rates to differences in ways to take money out of the company, there are numerous topics to study when analyzing the benefits of each corporation type. A few brief notes on each entity type are:
|Where is the Business Income Taxed?||Business income or losses are passed through to the owner(s), and taxed at their personal level.||The business income or losses stay within the company, and are taxed at the company level.|
|Qualifies for the 20% Qualified Business Income Deduction?||Yes||No|
|Tax Rate on Earnings||Individual owner’s personal tax rate||21% flat Corporate rate|
|Tax Rate on Dividends or Distributions||Distributions are non-deductible at the corporate level and non-taxable at the individual level.||Dividends are non-deductible at the corporate level and are taxed at a 0%, 15% or 20% capital gains rate at the individual level.|
Important questions to ask yourself are how much money do you need to take out of the company each year and how are you going to get that money out? From a C-Corporation, shareholders can withdraw funds as wages, and pay the applicable payroll taxes, and/or as dividends, which are subject to double taxation. From an S-Corporation, shareholders can withdraw funds as wages and pay the related payroll taxes, and/or take distributions which are tax-free (subject to basis limitations). However, the IRS will still require S-Corporation owners to pay themselves a reasonable wage each year.
If you prefer to keep money inside of the company, structuring your business as a C-Corporation to utilize the new flat 21% rate may be advantageous. However, if you are thinking of selling your business or desire to take distributions out of the company, it may make more sense for you to hold an S-Corporation. This avoids double taxation from dividends and paying additional payroll taxes.
Another item to consider is the Qualified Business Income Deduction (QBID). This deduction is available to S-Corporation shareholders but not C-Corporation shareholders. For more information on the QBID, please see last month’s article: https://willispc.com/tax-cuts-jobs-act-qualified-business-income-deduction/
A last, but often overlooked aspect of tax entity type considerations, are state taxes. In Michigan, for example, a separate Corporate Income Tax (CIT) return is required for most C-Corporations. This imposes a 6% tax on taxable income. On the other hand, Michigan based S-Corporations do not have a separate state tax return. Rather, income is reported by the shareholders on their personal state tax return which is taxed at the Michigan individual tax of 4.25%.
If you would like a complete analysis of the S-Corporation vs C-Corporation tax entity type that best suits your company, please contact our Jackson or Grand Rapids office.
Disclaimer: The information in this article is not tax advice. Each company is different and requires a complete analysis to make educated decisions. This article is intended to be informational only.