Is my business classified correctly?

August 15, 2019

This is the #1 question we've received since the 2018 Tax Cuts and Jobs Act. The headlines stole the show –  the tax rate for C-corporations dropped from a graduated 35% to a flat 21%. But there are little known advantages to remaining a pass-through entity. 

In general, choosing the right business entity involves various factors, and there is no automatic right answer.  Here things to consider:

  • While the TCJA dropped the corporate tax rate, it also created a significant new deduction for pass-through entities (S-corps, LLCs, partnerships, sole proprietors) called the Qualified Business Income (QBI) deduction. This allows pass-throughs to deduct up to 20% from their taxable income. Pass-through entities are taxed by applying the business income to the shareholders personal return.
    • Example: If your business produced $100,000 of taxable income, QBI would allow you to deduct up to $20,000 from that total, paying tax on only $80,000. This is a big incentive!
    • The details: Joint filers making less than $315,000 qualify for the full 20% and so will singles making less than $157,500. If you earn more than this, the percentage decreases accordingly. 
    • But hold up: if you are you in certain industries (i.e. accountants, lawyers, financial advisors), you may not fully qualify so it is always best to ask us.

Other things to consider before to a switch to a C-corp:

  • C-corps are subject to double taxation, meaning that corporate income is taxed once at the entity level and again when it’s distributed to shareholders as dividends.
  • Do you hold assets? Generally, it’s risky for C-corps to hold assets that are likely to appreciate (such as real estate). If the assets are sold for substantial gains, it may be impossible to get the profits out of the corporation without double taxation.
  • Other new factors to consider are reduced tax rates on individuals and super-generous first-year depreciation allowances.

While C-corps are now much more attractive thanks to the 21% tax rate rate, pass-throughs will still be preferred in many cases. 

Still unclear? That’s what we’re here for. Our team will analyze your particular circumstances and determine what classification is right for you.

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