Please note the information below is intended to provide generalized information that is appropriate in certain situations.  It is not intended or written to be used, and it cannot be used by the receipient, for the purpose of avoiding federal tax penalties that may be imposed on any taxpayer.  The contents of the information provided below should not be acted upon without specific professional guidance.  Please call us if you have any questions.

In the more than 30 years since the Tax Reform Act of 1986 (1986 Act) eliminated the General Utilities doctrine, a major goal of the small business community has been the avoidance of double taxation on income. Choosing a C corporation subjects the taxable income of the business to two layers of taxation; once when it is earned, and a second time when it is distributed to shareholders as a dividend or other form of distribution. Dividend and capital gains rates have been lowered since 1986, lessening the negative effect of this double taxation. Since then, most small businesses have opted out of the C corporation structure and have chosen to be taxed as a pass-through entity: as an S corporation or as an LLC (taxed as either a partnership or S corporation). This eliminates the double taxation of income. Of the two entities, the S corporation has the additional advantage of avoiding self-employment taxes on net income that is passed through to shareholders. LLC members who are similar to limited partners are likely able to gain similar treatment on their share of net income, but this remains a “gray” area of tax law, and it has elicited numerous court cases between taxpayers and regulators.

The TCJA has complicated the decision of whether a small business should operate as a C corporation or a pass-through entity because provisions in the TCJA do the following:

- Reduce the corporate income tax rate to a flat 21 percent.

- Grant a deduction against income for qualified business income reported by individuals, estates, and trusts (QBI deduction).

These two provisions take effect for taxable years beginning after December 31, 2017. Since both C corporations and pass-through entities are receiving tax reduction pursuant to the TCJA, it has become more difficult to choose. Is the low corporate tax rate enough to offset the eventual double taxation effect of operating as a C corporation? The flat 21 percent tax rate on corporate income is lower than all but the very bottom individual rates, but an individual with an eligible pass-through entity may get a 20 percent QBI deduction against income pursuant to new IRC Section 199A, which has the effect of lowering the effective tax rate on the pass-through entity income. When it comes to the ability of a business to deduct tax-favored fringe benefits, C corporations still offer the best choice for a business owner. Shareholder-employees of C corporations are treated in the same manner as non-owner employees, and a number of advantageous fringe benefits can be deducted in the calculation of net income, but are not taxable to the shareholder. Note, however, that the TCJA also scaled back the deduction of some fringe benefits, such as certain qualified transportation expenses that employers traditionally provide to their employees.