Marcum 2021 Year-End Tax Guide

The Effect of Tax Law Changes on Decisions Regarding Choice of Entity As a result of the 2017 Tax Cuts and Jobs Act (TCJA), the 2020 Coronavirus Aid, Relief and Economic Securities (CARES) Act and the Build Back Better tax legislation currently being considered in Congress, business owners have a lot to think about when determining whether their business entity choice is the most advantageous for tax purposes. FACTORS FOR DECISION-MAKING C-Corporations Current Legislation: The TCJA resulted in a dramatic decrease in corporate tax rates from a maximum rate of 35% to a flat 21%. While on the surface the significant drop in rates is appealing to those contemplating conversion to C-corporation status, business owners must also consider their personal tax rates when assessing the benefits of conversion. The issue of double taxation on corporate distributions continues to burden shareholders. C-corporation income is taxed at 21% at the corporate level when earned and then is taxed again when distributed to the shareholders, or when the corporation is sold, at a rate of 20% for most dividends and stock sales, and as high as 37% for certain dividends or sale transactions. This second level of tax can be significant for companies sold at a premium over book value. In addition, dividends and gains are currently subject to a net investment income tax at the individual level, at a rate of 3.8%. Companies that intend to retain profits may benefit from the lower 21% tax rate. If selecting C-corporation status, management should keep in mind that there might be an accumulated earnings tax, essentially a penalty tax on undistributed profits. The TCJA limits the use of net operating losses (NOL) arising after 2017 to 80% of current year taxable income. Although under the CARES Act this provision was eliminated for a period of time, the allowable NOL deduction will revert to the 80% limitation of current year taxable income for tax years beginning after December 31, 2020.

The 2017 TCJA also eliminates the ability for NOLs to be carried back to prior years when a corporation had taxable income. The CARES Act allowed 100% of losses from 2018, 2019 and 2020 to be carried back to the five prior tax years. For tax years beginning after December 31, 2020, this provision is back in effect. The elimination of the corporate alternative minimum tax (AMT) was an additional change as part of tax reform under the 2017 TCJA. This section of the act repealed the AMT and allowed corporations to claim outstanding AMT credits (subject to certain limitations) for years 2018 - 2020. For 2020, any AMT credits still outstanding should be fully refunded. Proposed Legislation: During the 2021 tax year, several tax proposals have raised additional factors to be considered when making decisions regarding entity selection. Furthermore, several of the CARES Act provisions that were specifically beneficial to businesses operating as C-corporations are set to expire. The House Ways and Means Committee’s tax proposals for the Build America Back Better legislation do not mention a change to the corporate tax rate, as was proposed in an earlier bill. However, a new corporate minimum tax has been proposed in the most recent bill. The proposed legislation will impose a 15% tax on large corporations with profits over $1 billion dollars. Additionally, a 1% surcharge would be assessed on corporate stock buybacks. Also included in the bill is a 15% country-by-country minimum tax assessed on the foreign profits of U.S. corporations in an effort to minimize the tax benefits of shifting profits and jobs offshore. These profits would be taxed at a 15% rate, and there would be a penalty rate imposed on foreign corporations that do not comply.

Pass-through Entities Current Legislation:

Unlike their C-corporation counterparts, pass-through entities and sole proprietorships are (usually) not taxed at the corporate level and, therefore, may be attracted by the 21% reduced corporate tax rate introduced by the TCJA. However, if a company intends to pay dividends or could be sold within a relatively short period, a conversion to C-corporation status may not be ideal because of the two levels of taxation.

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