Co-Author| Thomas J. Moul, CPA
One can only expect tax changes will come with every election, especially those resulting in a party switch. The recent election is no exception and regardless of where your opinions fall, there are some important tax reform possibilities that businesses should be aware of for 2017.
In this blog, we’ll specifically tackle the impact that these changes could have on C and S corporations.
S corporations have long been the entity of choice for small businesses as opposed to C corporation status because C Corp. imposes two levels of taxation on the same income (double taxation). To clarify; a C Corp. is taxed once at the entity level when the income is earned (at a rate of up to 35%) and again at the individual level when the corporation distributes the income to its shareholders in the form of a dividend (at a rate of up to 23.8%).
On the flip side, the S Corp. stockholder pays federal taxes at the individual level at a rate of up to 39.6% but can distribute earnings with no further taxation.
What’s Being Proposed?
So, what does this entity business have to do with the election? President-elect Trump’s administration has comprehensive tax reform high on their agenda and has included specific changes to C Corp. in their 100-day plan. The new Administration is proposing to:
• Reduce C Corp. tax rates to 15%
• Eliminate net investment income tax which is an additional 3.8% tax on the dividend distributions that certain stockholders pay on distributions
To further complicate matters, there are also proposals to lower the tax rates on income passed through from S Corp., but only if the earnings are retained in the business. Earnings distributed to stockholders would be potentially taxed at a higher rate. The lines between S Corp. and C Corp. become very blurred if indeed these proposals are passed. It would mean significantly lower taxes on C Corp. and their stockholders – resulting in businesses thinking seriously about changing their entity type.
What is the Likelihood of Change?
It is safe to say with a degree of certainty that tax reform will take place in 2017, at what level is harder to pinpoint. Reform may not be as sweeping as initially outlined during the campaign. However, both parties have shown support for lowering corporate tax rates, which could bump this to the top of the list. Lower individual taxes may follow, but at a slower pace or to a lesser extent than previously discussed. The House Ways and Means Committee tax proposal has many similarities to the Trump plan, but with enough differences to ensure debate and compromise. These differences could delay implementation until fully negotiated. Individuals are recommended to carefully monitor the impact of S Corp. income on their tax bill.
What Should You Do?
Be prepared and consider all of the options as we wait to see whether these significant corporate income tax changes happen. If you are currently an S Corp., take a closer look at how your company could see tax benefits as a C Corp. With fewer restrictions than your S Corp. status, such as limits on the type and number of shareholders, and the taxation of stockholder fringe benefits, changing your entity type may be a strategic move in your favor.
The recommended action, for now, is to maintain ongoing communication with your tax advisor. We are closely monitoring the situations and any subsequent developments. With that said, being proactive in developing a tax strategy that aligns with your corporate goals is always a good idea. If you are interested in discussing the pros and cons of entity types, please contact us to start looking at all options.