C Corp tax rate drops to 21% – is now the time to revisit choice of entity?

Written on Jan 18, 2018

By Christopher Axene, CPA

Chris-AxeneWith the 2018 C Corp tax rate now at 21% (in addition to the lack of a state income tax in Ohio on C Corporations) you might be flirting with the idea of converting an existing flow-through entity to a C Corp. But before the March 15 deadline for a retroactive conversion pushes you to do something rash, distance yourself from the hype and give the decision the careful consideration it deserves. After all, even with their lower tax rates, C Corps historically tend to score lower when it comes to popularity among business owners – and for good reason.

Before switching clients' choice of entity to a C Corp, tax advisers must fully understand the following critical points:

  • More manageable tax rate: Non-professional service entities will pay a 29.6% federal tax rate on business income (20% deduction for 2018 in addition to a reduced highest tax bracket of 37%) starting Jan. 1, 2018.
  • Observe the forest for the trees: While C Corp rates are now lower (8.6% to 16% depending on your facts) than pass-through rates, this short-term benefit must be weighed against the long-term detriment of being subjected to the two layers of tax on proceeds from the future sale of a business’s assets when the owner(s) retire.
  • Reinvest for success: Companies looking to reinvest capital – not distribute profits to owners – might be a candidate for a conversion to a C Corp.
  • Retained profits income won’t soften the blow: Unlike with pass-through entities, retained profits income in a C Corp do not increase stock basis for later tax-free distributions, nor will they reduce the taxable gain on the future sale of the company.
  • Flip-flopping is not an option: Once an S Corp election is terminated and the entity is converted to a C Corp, you must wait five years before you can re-elect S status.
  • Accounting method change could trigger tax liability: If the current business is on the “cash” method of accounting, a change to the “accrual” method will be required where average gross revenues exceed $25 million at time of conversion. This conversion likely will trigger a tax liability.
  • Potential planning for intangibles prior to conversion: The existence of business intangibles (e.g. goodwill) and who owns them should be evaluated and ownership identified and segregated in legal documents. This might allow Long Term Capital gain treatment to the shareholder directly, avoiding the C Corporation structure altogether for a part of any future business sale, as well as the double tax and lack of LTCG rate of a C Corp (21% vs 20%).
  • Taxable post termination period for S Corps: After a corporation conversion, there is a two-year post termination period to take out previously taxed S Corp income (“AAA” account). There is a ratio of AAA (tax-free) to previous C Corp E&P (taxable at 23.8% dividend rate) that is required so the entire post-termination period distribution may not be 100% tax free.
  • Potential deal breaker: In some cases, converting to a C Corp could trigger an immediate tax for sole proprietorships (including single-member LLCs) and partnerships with “underwater” balance sheets at the time of conversion.

Yes, if you want to take advantage of these new, shiny 2018 tax rates, your time is running out; but don’t let the threat of time push you into making a decision you will regret later. Choice of entity is a big decision. One in which you should carefully consider all possible ramifications. Some business owners might find it more beneficial to stick with a pass-through entity.

Tax Reform Update: Beware of the Pitfalls
Jan. 31 | 11 a.m.-noon | Webcast
Learn more Jan. 31 when five members of OSCPA’s Federal Tax Committee discuss pitfalls to consider when deciding choice of entity. This event is worth one hour of CPE.

Christopher Axene, CPA, serves on the OSCPA Federal Tax Committee and oversees the federal tax planning practice for Rea and Associates in the firm’s Dublin, Ohio, office.

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  1. John | Jan 18, 2018
    Great summary.  Should also consider for a multi-state entity the company and shareholder tax effects of C versus S in states other than Ohio.  Also consider non-resident state income taxes paid on distributive share of S Corp income (i.e. treated as distributions to S shareholders) may not likely (i.e. are they "business" deductions when they weren't under pre-2017 tax reform?) be allowable itemized deductions starting in 2018.  Net investment income tax may apply to C Corp dividends and gain on the sale (liquidation) of its stock even if the C Corp is closely-held.  Retention of E & P in a non-capital intensive C Corp will likely invite AET considerations and consideration needed to be given to PHC taxes.  Hopefully if Congress makes later changes that were detrimental to an earlier decision to revoke an S-election it will grant "amnesty" on the 5 year prohibition as it has done in several tax acts ago.  Thanks again.             

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