During a time of major changes to the tax laws and implementation of the Tax Cuts and Jobs Act (TCJA), many people are asking themselves if they are in a legal and taxation position that best suits the needs of their business. While there are many options for structuring your business, there are certainly benefits and drawbacks to each one. From the perspective of taxation and corporate structure, the main topics of conversation this year have revolved around restructuring to take advantage of the new qualified business income deduction (QBID) and reduced tax rates.
What is the QBID?
We have heard a lot in the news about Section 199A or QBID, but many taxpayers are still unfamiliar with how this new tax law will affect their business. While the calculation of the deduction can seem foggy and complex, the benefits are crystal clear. Generally, taxpayers who own businesses (excluding C corporations) will now get to deduct 20% of the lesser of qualified business income or taxable income. Like any tax benefits, there are limitations to this deduction that include issues such as wages paid to the taxpayer and employees, qualified trades or businesses, income limitations, and investment-related income. However, the deduction itself could play a major part in the decision of how you structure your business for the future. Keep in mind when making decisions that this deduction is currently set to phase out after the year 2025.
S Corp or C Corp?
S corporations are flow-through entities. This simply means that taxpayers who elect to be taxed as S corporations will give a K-1 to each shareholder in the company, and the tax on the entity will most likely be paid on each individual’s 1040 Schedule E. This type of entity will file an 1120-S and is required to file by March 15th of each year. This filing deadline allows for shareholders to receive their K-1s and file their own returns by the April 15th deadline. If necessary, an S corp is allowed a 6-month extension.
In most cases, an S corp will not owe a federal tax liability, as the income from the business is paid on the shareholder’s income tax return. However, an S corporation may owe state taxes. Wages can be paid to employees with this legal entity structure, and shareholders must receive a reasonable wage for their work. Contributions and distributions are generally not taxed, as the income was already subject to taxation when it was earned. The structure can operate with a single shareholder or multiple owners. There is a limited amount of liability coverage for the owners of this entity type.
A new topic that was addressed in the TCJA was the taxation of the C corporation entities. In prior years, the C corp was taxed at an income-dependent rate. Now, there will be a flat tax rate of 21% without subjection to self-employment taxation. Shareholders in the C corp will not receive K-1s, and income received will not be taxed on their individual returns until the income is distributed to them. The entity will file a form 1120 and has a tax filing deadline of April 15th. Fiscal year entities will follow a three month and 15-day deadline after the close of their fiscal year. A C corp is also allowed a 6-month extension, if necessary.
C corp owners typically operate in an employer/employee relationship, allowing for shareholders to receive additional benefits such healthcare and housing. The C corp can pay wages to employees and report these wages on a W-2. The liability protection provided to the shareholders of the C corp are certainly not something to ignore. While the C corp will not be allowed to take the new QBID deduction, the 21% tax rate will allow some business owners to receive a lower tax liability rate than in prior years. However, for some small business owners, this flat rate might mean paying a higher level of tax than their company has ever seen.
Entity Taxation Election
It is not too late to set your business up for success. For many C corp owners that have never paid a tax rate as high as 21%, there is an option to reduce the rate of taxation for your business. A C corp can elect to be taxed as an S corp, allowing for the 20% QBID deduction to reduce your taxable income and avoid the flat rate of the C corp tax.
When making the decision to change your tax election, there are many factors to consider. Aside from the basic laws of a C corp and S corp business entity, the election to change the taxation is a choice that cannot be undone for 5 years. Making an S corp taxation election could potentially cause a C corp to lose carryover attributes such as the net operating loss, among other business attributes.
Changing your business structure or taxation election is not something that should be done without help from a professional. Family Farms, LLC will help keep you informed and help you make decisions for your business that are well researched by an individual who has countless hours of education in the new TCJA laws.
Disclaimer – Descriptions provided in this article are presented as generalities. There are many factors not listed above which may impact your tax positions. This article should not be considered legal or tax advice. For advice on a specific transaction, please contact the AgriSolutions tax department at firstname.lastname@example.org .