The 2017 Tax Cuts and Jobs Act established for 2018 a new flat 21% federal income tax rate for C corporations (“C Corps”). This 21% rate is significantly lower than the 2017 top C Corp. rate of 35% and the new 2018 individual tax rate of 37% which would apply to ordinary income from pass-through entities such as partnerships or S corporations (“S Corp”).
So, shouldn’t all companies now opt to be taxed as C Corps? Not so fast. C Corps continue to be taxed at two levels; first at the corporate level of 21% on its earnings and a second time at the shareholder level on dividends at a rate of up to 20% and likely a Net Investment Income Tax (“NIIT”) of 3.8%.
A federal only tax comparison of a C Corp. vs. an S Corp. with net income of $ 1,000,000 might look as follows:
Pretty close but an edge to the pass-through without considering the potential added benefit of the QBI deduction available to certain owners of pass-through entities such as S Corps and Partnerships, but not C Corps. State income taxes were also not factored in order to simplify these examples.
Using the same comparison, assume the net income is $5,000,000 resulting from the gain from selling its business in an asset sale.
The vast majority of sales of closely held businesses take place as asset sales and give rise to capital gains when intangible assets such as business goodwill, customer lists, etc. are either all or a substantial part of the assets sold. The pass-through entities allow the capital gains to be subject to the capital gains tax at a maximum rate of 20% and, if assuming the owner was active in the business sold, the gain is also not subject to the NIIT.
In conclusion, the C Corp. is likely still the less desirable entity type for most closely held businesses, especially if you feel you one day might sell your business.
Do you have questions about whether the C Corp. is the right entity type for your business? Consult an adviser at BSA or a tax adviser to review the entity tax status of your business.