Posted by Fred Lake

Using Tax Cuts & Jobs Act (TCJA) to Adjust Your Business Entity Choice

Using Tax Cuts & Jobs Act (TCJA) to Adjust Your Business Entity Choice

There was a historic adjustment made by the Tax Cuts and Jobs Act (TCJA) to the federal tax code. Although this triggered a significant tax break with many business entities, many had way better chances compared to others.  

Rethinking your business is a factor of the nature and structure of your business. There are, however, other factors to keep in mind besides using the tax rate to judge. 

Changing Partnership or Sole proprietorship to S Corporation or LLC: Is It advisable?

For people with a business under the sole proprietorship or partnership umbrella, there might be speculations whether switching to S corporation or limited liability company (LLC) will be to your advantage. When you consider the tax code, these business entities receive almost the same treatment. When you receive income from any of these businesses, it is transferred to individual income tax returns. With this, your tax return will not make any meaningful adjustment on switching your business to LLC or S corporation.

The silver lining here, however, is that owners of pass-through entities can deduce that is as much as 20% of the qualified business income (QBI). There are, however, exceptions involving personal businesses, including law firms and medical practices. They are subjected to qualified business income with deductions absent once total taxable income gets to $415,000. This is where the business owner loses the 20 percent deduction benefit.

On the bright side, however, there are other cool reasons to restructure your business to an S Corp or an LLC. One glaring reason is that it gives you the ability to separate your business asset from your personal asset. This serves as a form of protection from creditors. Be sure to talk with your tax advisor as he can help you decide if this is a move worth making.

Changing Pass-Through Business to a C Corp: is it Advisable?

For people with small businesses operated as a sole proprietorship, S Corp, partnership, or an LLC, making a switch to a C corp is something that might appeal to you. The Tax Cut Job Act reduced the tax rate for top corporate from 35 percent to 21 percent for C corps. The QBI deduction discussed above only reduces the tax rate on pass-through income to 29.6 percent. 

Another thing that will make matters complicated is that QBI deductions will expire come 2025. This, however, might not be valid if congress extends it. The corporate tax break, for now, holds permanently. 

It appears like this is a pretty easy choice. The 21% tax rate is appealing to everyone, as the absence of an expiry date makes it more appealing. It is, however, not as straightforward as it seems. Judging by the TCJA, corps are seen as a distinct and separate legal entity from their shareholders. This qualifies them for double taxation. 

This is how double taxation works: whatever these companies earn every year, they have to pay tax on it, the same way everyone does. When these corporations distribute their dividends to shareholders, the recipients also must pay the tax on what they get, not minding that these earnings have once been taxed.

When you consider it critically, C corp may or may not be the best choice for your entity. For instance, you might be one of the owners or the owner of a pass-through entity, making a good profit. If the entity prefers to reserve its profit to fund future growth without sharing out the benefit, switching to a C corp will be a very terrific choice.

When you consider it again, and your business generates tax losses, operating as a C corporation comes with no tax benefit. This also applies to a profitable business that shares out its entire income to the owners. Running as a pass-through entity is a good idea in both cases.  

With the TCJA, there are some unique choices that your business will enjoy. Make sure you talk to a qualified tax accountant to help you make a fitting decision for your business.

Fred Lake
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