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Restructuring your business to maximize savings under the 2017 Tax Act

Changes to C Corps and Flow-Through Entities under the 2017 Tax Act

Restructuring your business to maximize savings under the 2017 Tax Act

by Christopher Branson, Partner

In our last business blog post we detailed the changes to C Corps and flow-through entities under the 2017 Tax Act. Many businesses will already experience savings under the 2017 Act, but for some businesses, there may be opportunities for additional savings. Here are some strategies to consider.

1. Consider converting to a C Corp, particularly if the business can avoid double taxation and pay only 21%.

  • A C Corp can avoid double taxation by reinvesting profits in the business rather than distributing earnings as dividends (which are taxed a second time).
  • For example, C Corps work well for growing manufacturing businesses that plow earnings back into the business in the form of research and development, capital investment, and the like.
  • These businesses are taxed only the 21% on earnings, not the additional 20% rate on dividends.
  • A flow-through entity, in contrast, will result in taxation on all earnings at a rate up to 29.8% whether the earnings are distributed to the owners or not.

2. If your business is a C Corp or is converting to a C Corp, consider issuing Qualified Small Business Stock to investors under IRC Section 1202.

  • For businesses with gross assets under $50 million, this stock can later be sold and in many circumstances at least 50% of any gain avoids taxation (i.e., 50% of the gain is excluded from income).

3. Consider converting to a flow-through entity if the business is eligible for the 20% deduction on QBI

  • For flow-through entities, this deduction can reduce the effective tax rate to 29.6%.
  • Remember, this deduction is capped and phased out for many professional businesses and other service businesses when taxable income exceeds a certain amount. For those businesses, without the 20% deduction, earnings of flow-through entities are taxed at the top individual rate of 37%.

4. If you have a C Corp, but would like to take advantage of the 20% deduction for flow-through entities, consider converting to an S Corp, either immediately or at the end of the year.

  • For a C Corp, converting to an S Corp is simpler than converting to another form of flow-through entity. Converting to an S Corp can be accomplished without dissolving the existing C Corp and simply requires the filing of IRS form 2553 (the so-called “S Election”).
  • But beware – be sure to check first to see if converting your business to an S Corp could trigger tax on built in gains.

A Word of Caution

With some planning, you can determine the method of restructuring that might produce additional tax savings for your businesses. But one final word of caution: although the reduced rates for C Corps are “permanent,” the new reduced rates for flow-through entities are scheduled to sunset in 2025, at which time the higher 2017 rates are scheduled to be restored. It is hard to know if Congress will extend the new lower rates at that time or let them lapse. So keep in mind that whatever you do, additional changes or tax planning may be needed in 2025.