Updated: 02 July 2020
To Convert or Not Convert
With the new tax law (TCJA Act), there has been a permanent flat 21% tax rate on C-corporations from January 1st, 2018, naturally many taxpayers may be interested in switching their entity to C-corporation to evade paying high tax.
C-Corporations usually enjoy an improved deductibility of owner fringe benefits, avoidance of AMT, the right to choose any fiscal year-end, and a lower tax rate on most dividend income. The primary driving force for companies is the new 21% rate; however, in reality, taxpayers may not receive any real value and in fact pay a high tax bill if they switch their entity to C-Corporation. It is important to note that the C-corporation rate applies only to taxable income of a company.
Very few businesses will actually benefit from the 21 % C-corporation tax rate. So, the emphasis should be on high bracket individual holders. The top bracket drop is from 39.6% to 37%, effected by 20% deduction for qualified business income (QBI), for pass-through entities, such as sole proprietorships, partnerships, Trust and S corporations.
The 21% rate can be paid on the gain from the asset sale, it may be attractive to hold the net proceeds and invest the funds within the corporation, thus continuing the deferral of the secondary individual tax. However, in these cases, as well as when the gross income from operations dwindles relative to personal holding company (PHC) income, taxpayers may increase their exposure to the PHC tax.
Lastly, a C-corporation, after the termination of its status, can switch back to an S corporation without the IRS’s consent. If an S corporation revokes its status in 2018 due to the lower C-corporation rates in TCJA, it will not be able to reelect S status until 2023. TCJA’s drop of Corporate tax rates to a flat 21% is far from a key solution, only through facts and circumstance-based analysis, the favorable outcome can be expected.
For more information and detailed analysis, please visit: Another look at C corp. vs. S corp. in light of tax reform