Now that the highest individual tax rates is 39.6 % as compared to the highest corporate tax rate of 35% are S Corporations still the most efficient choice for your business? How would the new 3.8 % tax on net investment income factor into this decision?
It is not as simple as just comparing the individual and corporate tax rates. There are still many factors to consider including:
- Double taxation of income each year – while the individual could pay tax at a tax rate of 39.6 % on their S corporation distributive income, the C corporation would pay tax at the corporate rate of 35% and the dividends paid to the shareholders would be subject to the 20% qualified dividend tax rate plus the 3.8 % net investment income tax rate for a total of 23.8%.
- Double taxation upon the sale of the business – the same concept would apply as the double taxation mentioned above. These numbers are usually significant on the exit of a business and it is not unusual to have the total individual and corporate tax rates by near 60%.
- Pennsylvania rate differences - The Pennsylvania individual tax rate is 3.07% as compared to the 9.99% corporate rate.
- Medicare tax exclusion for material participation- The net investment income tax applies to passive investments in business and portfolio income. This 3.8% tax does not apply to owners that are actively involved in their businesses. Although many business owners would not pay this level of tax on their S corporation distributive income the tax would apply to passive owners.
The choice between a C corporation and an S corporation is complex and involves many factors. This decision can have significant long term tax impact and it should be discussed with your accounting, tax and legal advisors before any decision is finalized.
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