by Scott Moser

Since 1986, there has been a steady decline in the use of a Regular Corporation (C-corp) as an entity structure for operating a business.  The cause for this change was simple: Congress burdened C-corps with two levels of tax, one at the company level and then again at the individual level.  In 2017, this total tax burden could exceed 50.5%, not including potential state income taxes.  In contrast, the maximum individual rate that applied to businesses operating as an S-corp or Partnership was only 43.4%.  For most companies, the decision was easy: elect S-corp status and enjoy the lower tax rate. 

The new tax law levels the field, but also makes the entity selection decision more difficult.  Tax rates for all business entities have declined.  However, the C-corp rate reduction was more dramatic, falling from 35% to 21% at the business entity level.  Below is a comparison of the maximum rates that includes the C-corp double-tax and a new twist, the “pass-through entity deduction”.

Absent the pass-through entity deduction, the C-corp has the edge under the new tax law.  C-corps have the added advantage of deferring the second level of tax into future years at potentially lower tax rates to provide an even greater edge over pass-through entities.  However, for those S-corps and Partnerships that qualify for the new pass-through entity deduction, this entity form still rules.  Most S-corps and Partnerships will qualify for some portion of the pass-through deduction, but there are numerous rules that serve to limit the deduction that will need to be considered.  In addition, the tax table reports the maximum rates which can oversimplify the comparison.  Every taxpayer is likely to face some different mix of rates and phaseout thresholds that favor one entity form over the other.  Payroll taxes, retirement funding, medical benefits, alternative minimum tax and the net investment income tax can greatly impact the comparisons! 

This new law will undoubtedly result in late nights for tax advisers to determine how to maximize the new deduction, and certainly does not qualify as simplification.