One of the most significant outcomes of the Tax Cuts and Jobs Act (TCJA) is the startling difference between the new tax rates for C corporations and for pass-through business income. While entity choice isn’t just about tax rates, the rate changes are drastic enough to prompt many pass-through business owners to consider a conversion to a C corporation.
The changes made in the TCJA affecting this choice are significant. C corporation tax rates have been reduced from 35% to 21%, while the top tax rate on individuals has only been reduced from 39.6% to 37%, and “passive” owners tack-on another 3.8% net investment income tax not levied on C corporations. Qualifying flow-through entity (FTE) owners can use a deduction of up to 20% of their FTE income, potentially lowering their effective federal tax rate on FTE income to 29.6%. But the reduced rate for individuals and the 20% pass-through deduction are both scheduled to expire at the end of 2025, while the C corporation rate cut is permanent.
The 21% rate on business income for a C corporation is a compelling reason to consider an entity change. That level of cash flow from tax savings each year is a very powerful tool to enable a business to stay competitive with other C corporations in its industry and to fund future growth. But there are many other tax considerations beyond simply a comparison of federal income tax rates.
This Grant Thornton white paper will model several comparisons between FTE and C corporation treatment with a focus on the following important considerations:
- Rate differences factoring in participation in the business, earnings distributed, and eligibility for the 20% deduction
- The potential sale of the business
- Estate and gift tax planning advantages for pass-throughs
- State tax differences
- International tax treatment
Click the download button above to read our comprehensive report on tax reform and its effects on entity choice.
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