The Effect of Tax Reform on Choice of Entity Considerations

The Effect of Tax Reform on Choice of Entity Considerations

Harry P. Wills III, CPA, CGMA, Partner
Posted by Harry P. Wills III, CPA, CGMA, Partner on Jun 19, 2018 10:00:00 AM

ChoiceSince tax reform reduced corporate tax rate to 21 percent from 35 percent, it is time for all pass-through entities, including partnerships and S corporations, to evaluate the choice of entity. Planning to convert from a pass-through entity to a C corporation requires thoughtful consideration, analysis, and planning.

WHY CHOOSE AN ENTITY?

  1. The 21-percent corporate tax rate is lower than the individual tax rates, which can be as high as 37 percent. As a result, a C corporation entity should have more after-tax cash available to re-invest or reduce debt.
  2. There has been a reduction of the effective tax rate differential between corporate and pass-through entities. Because of this, even with two levels of taxation, a C corporation structure may give owners greater after-tax cash value compared to a pass-through entity. 
  3. Company owners have a fiduciary responsibility to their shareholders and partners to evaluate their entity choice of entity given these changes.

WHAT KEY FACTORS SHOULD YOU CONSIDER?

  1. Taxable Income - When choosing an entity, owners must consider plans to generate income that will be subject to taxes, now and in the future.
  2. Section 199A - The Section 199A Deduction can reduce a pass-through owner’s taxable income. You must evaluate the extent to which you will be eligible for this deduction as part of the Choice of Entity analysis.
  3. Future Plans:  Reinvest or Distribute - Corporate entities have better abilities to generate revenue on reinvested cash because of lower initial tax liability. As an owner, you will need to evaluate whether you plan on reinvesting or distributing the after-tax cash, as this can impact your overall tax rates.
  4. Domestic Tax Reform - Other tax reform provisions can impact the company’s overall income tax liability. These provisions can increase the benefits of an entity change. For example, tax reform changes have affected rules surrounding the amount and timing of income recognition. You can benefit from these changes by selecting better accounting methods following an entity change.
  5. International Tax Reform - International tax reform has created several issues that may result in many incremental tax burdens to a pass-through entity compared to a corporate entity. These probable liabilities can greatly impact the overall effective tax rates.

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