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Which Choice of Entity is Best Under Tax Reform? The Top Five Things to Consider

Written on July 26, 2018

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The Tax Cuts and Jobs Act (tax reform) includes major changes that affect an organization’s choice of entity. This includes the permanent change in the corporate tax rate to a flat 21 percent and the qualified business income (QBI) deduction available to individual owners and pass-through entities. Before tax reform, businesses operating as pass-through entities only considered their choice of entity during the formation of their companies, but that’s not the case anymore. Now that tax reform has shaken things up, it’s time to re-evaluate your organization’s choice of entity.

Here are the Top Five Things to Consider

  • Taxable Income
    Inherent in considerations to structure companies in a tax efficient manner is an expectation that the company plans to generate current and future income that will be subject to taxation.
  • Section 199A
    The Section 199A Deduction may reduce a pass-through owner’s maximum individual effective tax rate from 37 percent to 29.6 percent. While we are waiting for additional guidance from the IRS and Department of the Treasury on this area, it is critical to begin evaluating the extent to which the pass-through owner will be eligible for this deduction as part of the choice of entity analysis.
  • Future Plans:  Reinvest or Distribute
    The ability to generate incremental revenue and value on reinvested cash favors a corporate entity, due to the lower initial tax liability. It’s important to evaluate whether a company plans on reinvesting or distributing its after-tax cash, as this may significantly impact the overall effective tax rates.
  • Domestic Tax Reform
    Impact of other tax reform provisions on the company’s overall income tax liability may increase the benefits of an entity change. For instance, tax reform changes have affected rules surrounding the amount and timing of income recognition. A company may benefit from these changes by selecting more advantageous accounting methods following a change in entity.
  • International Tax Reform
    International tax reform has created a number of complexities that may result in significant incremental tax burdens to a pass-through entity as compared to a corporate entity. These potential tax liabilities may significantly impact the overall effective tax rates.

S Corporation or C Corporation?

Under the new tax law, should your organization be structured as a C corporation or as an S corporation? It’s your company’s fiduciary responsibility to your shareholders to evaluate your choice of entity in light of to the many changes in tax reform.

Before tax reform, the pass-through nature of an S corporation proved to be a popular choice for businesses to avoid double taxation. While double taxation hasn’t changed, the economic impact has, due to the reduced tax rate on C corporations. Now, a C corporation may yield more after-tax cash available because of the change in the corporate tax rate, which is significantly lower than the individual tax rates. However, each company’s situation is unique, and converting to a new entity structure requires a significant amount of planning and thoughtful consideration. Warren Averett can help you review your entity structure to determine if a different election should be made. Contact your Warren Averett advisor today.

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