As a result of tax reform under the Tax Cuts and Jobs Act (TCJA), C corporations were also affected. This will directly impact C corporation shareholders.
Under previous law, the tax rate a corporation would pay on its profits could be anywhere from 15% to 35%, depending on the corporate taxable net income level. With tax reform, all C corporations pay a flat 21% on their profits, regardless of the taxable income amount.
For C corporations with profits in excess of $50K, this is obviously going to result in potentially significant tax savings – but what about corporations with profit typically lower than that? In that case, businesses may actually pay more with this change – jumping from a 15% to 21% corporate tax rate.
With that in mind, businesses will want to plan for the additional tax and may even want to reassess entity type to determine if another business structure would be right. With the (up to) 20% pass-through (Section 199A) deduction now available for other entity types, corporations could possibly realize tax savings by switching!
When a C corporation converts to an S corporation, a built-in gains tax is imposed. The recognized built-in gains were previously taxed at the highest rate of tax applicable to corporations, 35%. With the new the tax bracket reorganization, the rate drops to 21%. Transitioning from a C corporation to an S corporation is now much more affordable compared to previous years.
There are a few laws that did not change with the TCJA. The accumulated earnings tax (AET) imposed on C corporations with retained earnings deemed to be unreasonable and in excess of what is considered ordinary (accumulations beyond $250,000), remains at a 20% tax rate. The personal holding company tax also remains at a 20% tax rate. A corporation is recognized as a personal holding company if 60% of income is from investments.
The TCJA repeals C corporation alternative minimum tax (AMT) for tax years beginning after 2017. Under prior law, AMT applied if a C corp’s tentative minimum tax ((AMTI less $40,000 exemption) x 20%) exceeded its regular tax. Individuals, trusts and estates are still subject to AMT. The elimination of C corp AMT opens up the possibility that C corps may more freely enter redemption buy-sell agreements after 2017.
Be sure to contact your tax professional to determine which entity is the best option for your specific needs!