Now that we have had some time to digest the Tax Cuts and Jobs Act (TCJA) legislation passed in late 2017, it seems like a good time to sit back and ask yourself, “Am I in the most tax-efficient structure for my business?” Many considerations go into structuring a business venture. Taxes may not be a motivating factor, but who wants to pay more taxes anyway! Each entity structure has pros and cons, and other business factors may be the primary driver for these choices, but the passing of the TCJA changes the tax implications of each structure.
Corporations come with the double layer of tax, but now with a 21% corporate income tax rate, this may look a lot better to a professional service organization. If your organization is continuing to leave all of its profit in the business or bonusing out the majority of the profit to the key decision-makers, the 21% tax rate is going to be an attractive alternative. If your organization is going to dividend out the remaining, 79% of after tax dollars to its shareholders, you may be looking at a combined income tax rate of 40%, but that will adjust depending on the level of dividends to those owners due to the two layers of tax.
Pass-through entities (S-Corporations, Partnerships, and Single Member LLCs) were awarded the new Qualified Business Income (QBI) deduction. This is a deduction of up to 20% on the income of the entity as long as the company meets a certain requirements. However, for those in the professional services industries, no such luck (if your taxable income exceeds $415,000 (MFJ)). Although, if you are in an engineering or architectural firm, you got the golden ticket, as the deduction was awarded to those organizations. The individual owners of the pass-through entities pay tax of up to 37% top tax rate (can be reduced to approximately 30% with the QBI deduction) but do not have the second layer of tax that corporations pay when distributing net profit dividends to their shareholders.
This is an all-time-low corporate income tax rate, and there has been some grumbling that there could be a change in rates if we see a change in the country's leadership, but those are a lot of hypotheticals for which no one has the answers. Many of the "Individual" provisions of the TCJA are set to expire in 2026. The QBI deduction will be an area to keep your eye on. The government likes to keep about an 8% - 9% top income tax rate difference between pass-throughs and corporations, but as we hear some politicians lament over the lower tax rates and ways to ensure that the top earners are paying their "fair-share" all of this could change. It is important that you ensure that you are in the best structure for your business, not solely based on the current tax environment.
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.