By now we’ve all heard a lot about the Tax Cuts and Jobs Act, including the reduction in the corporate tax rate to 21%. Some of my LLC and S corp clients have already contacted me asking if they should convert to a C corp.
The first thing I tell them is that I’m not a CPA or a tax attorney. So they need to have their tax advisor do a “deep dive” into the numbers to see whether they would save any money.
After that disclaimer, I tell them to keep in mind that C corps are still subject to double taxation. The combined rate that the corporation would pay on its net income (even if only 21%), plus what the shareholders would pay on any money distributed to them, is still likely to be higher than the single rate the individuals would pay if the entity remained a flow-through. This is why most of my CPA and tax attorney colleagues generally discourage the notion of immediately converting to a C corp to take advantage of the new tax rate (although they say there could be tax savings in particular cases).
In some cases, for example, the income allocated to the individuals will qualify for the 20% deduction for “Qualified Business Income” from a pass-through entity. See the excellent article on this topic by my friend H.T. Astrov. This will make the double taxation less painful in cases that qualify for the deduction. Whether that justifies converting to a C corp, however, depends on the numbers.
Even if the entity doesn’t plan to distribute money in the near term, the potential tax hit if you end up doing a sale of assets down the road is still probably steep enough to remain an S corp or an LLC, and not convert to a C corp, which would be subject to double taxation in such a transaction. And it’s very difficult, if not impossible, to convert back from a C corp to a flow-through prior to the acquisition.
Also, the expense of converting to a C corp could be significant, especially if you are an LLC, in which case you will have to completely redo your organizational documents.
So don’t automatically convert to a C corp just because you’ve heard about the new 21% tax rate. Have your tax adviser crunch the numbers to see if you stand to save any money. I know some good ones if you need a referral. And if the decision is to convert, I’d be happy to help! Click here to contact me.
This article is not intended and should not be relied upon as legal or tax advice pertaining to any specific matter. You are encouraged to seek competent legal and tax counsel before proceeding with any transaction involving any of the matters discussed above.