One of the major changes in the new tax law is the slashing of the corporate tax rate. Previously, corporations were subject to four narrow tax brackets that ranged from 15% to 35%. As of January 1, 2018, the old rates were replaced by a flat rate of 21%.
Even with lower individual tax rates provided in the new law, the new corporate tax rate is lower than five of the seven individual tax rates and this creates a situation where we will need to reexamine many of the tax strategies that have been used in the past.
In recent years, Partnerships and S Corporations have been very popular, and the tax benefits they provide is one of the major reasons for that. Partnerships and S Corporations don’t pay income tax, but their income is passed on to the partners or shareholders where it is taxed at the individual tax rates, which have often been lower than corporate tax rates. Now that the corporate tax rates are going to be lower than all but the lowest of the individual tax rates, it may seem like a no-brainer to change from a Partnership or S Corporation to a traditional C Corporation, but, of course, it’s not that simple.
C Corporations still have the disadvantage of double taxation because the dividends they pay send money that has already been taxed at the corporate level on to the individual stockholders where it is taxed again as dividend income. C Corps also have disadvantages when they want to distribute out anything owned inside the corporation. When these disadvantages are considered, it still appears that in most cases the total taxes paid on income coming through a C Corp will be higher than in a Partnership or S Corp.
Even with the new 21% flat corporate tax rate, C Corps still aren’t quite on a level playing field with Partnerships and S Corps, but the gap that existed before has gotten much narrower and could make C Corps much more popular going forward.
Michael Anderson, CPA