Carissa A. Conley, CPA
With the newly lowered corporate tax rate, many pass-through businesses are wondering if they should now convert to a C Corporation. The Tax Cuts and Jobs Act (TCJA) reduced the corporate tax rate from a maximum of 35 percent to a flat rate of 21 percent and eliminated the corporate AMT.
Meanwhile, income of pass-through entities is taxed at the individual taxpayer level which is still based on graduated rates up to a maximum of 37 percent. While this initially sounds like a no-brainer, in most cases, small businesses will be still pay less tax as a pass-through entity.
Even though a C Corporation is only taxed on its net income at a rate of 21 percent now, there is still the issue of double taxation when shareholders take dividend distributions. Depending on the shareholder’s tax bracket, these dividends which have already been taxed at 21 percent, are now taxed again at a rate up to 20 percent (for those in the highest tax bracket) plus another 3.8 percent for Net Investment Income tax.
This brings the effective tax rate on dividends to 39.8 percent, which is higher than the maximum individual tax rate of 37 percent. Note that this is only considering the federal tax and there would be additional tax at the state level for both the corporation and the shareholder.
