Should Your Company Restructure to Take Advantage of New Tax Laws?

Intuit QuickBooks Blog
by Cathie Ericson
May 18, 2018
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According to the 2018 Spring Bank of America Small Business Owner Report, business owners are enthusiastic about the new tax policy, with 63% saying it makes them more optimistic about their business outlook, and almost 60% calling it a “game changer for small business overall.” In fact, nearly three-quarters expect to see savings from the tax policy changes.

One way that small businesses may realize some of these savings is through a restructuring of their business to take advantage of two parts of the tax code that are particularly impactful.

“I have had many clients come in wondering if their current business entity still makes sense,” says Brendan Lund, an attorney at law firm Hopkins & Carley, and he’s been encouraging them to at least talk through the benefits of moving from one configuration to another.

Here’s some food for thought and that he and other tax experts shared.

The Tax Implications of Your Business Structure

The first thing to know is that your business structure has such a crucial effect on taxes because it dictates whether you pay taxes as an individual or a corporation.

If your business is a sole proprietorship, limited liability company (LLC) or S-Corporation, all known as “pass-through” companies, it means your income and business expense deductions will be reported as personal income taxes, rather than as business taxes.

That may be attractive because the top individual tax rate is now 37%, down from 39.6%, and owners of many pass-through entities can deduct up to 20% of pass-through income.

But if you’re a C-Corporation, the business becomes a separate legal entity from you as the owner, which means that your taxes are filed on a corporate tax return, rather than on your personal taxes. That can be attractive since corporate tax rates are falling to 21% from 35%.

But as you might imagine, there’s more to these potential changes than meets the eye at first glance.

What to Consider As a “Pass Through” Business

1. Not everyone qualifies for the 20% reduction, and it can be challenging to know if you do.

First off, your income must be less than $157,500 if filing singly or $315,000 if filing jointly, but that’s the only part that is cut and dry. The parameters are head scratching, and the law currently lacks clarity about what types of business qualify, says Monic Ramirez, tax partner at accounting firm Sensiba San Filippo.

For example, professionals including doctors, lawyers, and others in “service businesses,” as well as those in any business where the “principal asset” is “the reputation or skill of one or more of its employees or owners” don’t qualify for the pass through.

But for many professionals, their name is their brand and their business. If your advertising says your shop has the “best coffee in town,” does that disqualify you?

And, she points out, some companies may have a clearly defined service line, but also do something ancillary that doesn’t qualify. So an architectural firm (allowed) that also provides some legal services (not allowed) could be in a quandary.

“There’s a lot of subjectivity,” Ramirez says. In fact, on this puzzle, even your CPA might not yet know if you qualify.

The American Institute of CPAs has asked the Internal Revenue Service and the Treasury Department to more clearly define the term “qualified business income” for pass-through entities under the new tax law. In the meantime, many professionals wait.

2. The law is not permanent.

The pass-through deduction is currently designed to sunset in 2025, so the benefits you enjoy converting from a C-Corporation might be relatively short-lived, points out Ramirez.

What to Consider As a C-Corporation

1. You might be taxed twice.

Owners of a C-Corporation must report any dividends they receive on their personal tax return. That means that if you are receiving ample distributions, you will be taxed at both levels.

“If you rely on the income or distributions as a small business owner, then a flow-through structure might make more sense,” says Lund. However, if you are primarily planning to reinvest the dividends, then enjoying the lower corporate tax rate might make sense.

2. Future ownership possibilities may be more limited.

S-Corporations only allow U.S. persons to be shareholders, which means they can’t be owned by other corporations, partnerships, or LLCs, points out Samuel Hicks with Stern, Kory, Sreden & Morgan.

3. You will already be poised to go public.

However, if you have the dream of someday going public, the easiest configuration is as a C-Corporation, Hicks says. That’s because publicly traded partnerships, like LLCs, have restrictions on the types of income they can earn and pass through to owners; if too much non-qualified income is earned by a pass-through, it could be taxed as a corporation.

In that case, Hicks says he would typically recommended that the entity change its structure to a corporation to avoid the complications that come with a partnership potentially taxed as a corporation.

4. You’ll have to adapt to different procedures.

Becoming a C-Corporations involves more than just changing your structure. For example, C-Corporations have to identify shareholders and directors, develop bylaws, issue stock, hold annual meetings, and file annual reports.

5. You will be stuck for five years.

If you switch from an S-Corporation to a C-Corporation, legally you must wait until the fifth year to become an S-Corporation again.

The Bottom Line: Run Your Numbers With a Professional

The twists and turns of the new law means there are few scenarios where it is going to be a black-and-white situation, Ramirez says.

“Business owners contemplating a change would be wise to meet with an accountant and discuss the many nuances to strategize what makes the most business sense for you and help you prioritize based on your goals for the future.”

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