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Time to Reconsider Your Choice of Entity?

February 22, 2018

By: Amanda Wilson

One of the most publicized changes made by last year’s Tax Cut and Jobs Act was a reduction in income tax rates for corporations and individuals. The maximum corporate tax rate has been permanently reduced from 35% to 21%, and the maximum individual tax rate has been reduced temporarily (through 2025) from 39.6% to 37%. These changes reopen the age old question of what type of entity is best from a tax perspective. It used to be relatively simple to answer – pass-through entities such as partnerships and S corporations were the preferred structure where business realities allowed for that choice. In light of the tax rate changes, this may no longer be the case and it may be time to reconsider your choice of entity.

If a business is taxed as a corporation, the business will pay tax on its taxable income at a 21% rate, meaning $21 of federal income tax on $100 of taxable income. In contrast, if the business is organized as a partnership, the income is passed through to the partners and reported on the partners’ tax return. If those partners are individuals, the partners are potentially paying $37 of federal income tax on the $100 of taxable income (if the income is ordinary such as rental income). As I have previously discussed, the Tax Cut and Jobs Act provides for a deduction on qualified business income, which would include income from partnerships. Even in the best case scenario where the partners are able to take the maximum 20% deduction on qualified business income, which will often not be the case, the maximum deduction would reduce the tax to $29.60.

One of the key benefits of a pass-through over a corporation is that there is an additional layer of tax (at a rate of up to 23.8%) when the corporation distributes its profits out to its shareholders. If the corporation distributes the $79 of after-tax dollars discussed above, there would be an additional $18.80 of tax, resulting in a total tax of $39.80. Even with the tax rate reduction, this means that a corporation will result in less after-tax dollars ($60.20) for its owners than a partnership ($70.40) if the profits are distributed out. However, many companies do not distribute profits to its owners, instead keeping the profits to grow and expand the business. For those businesses, a corporation may provide a better tax answer than a pass-through in this post-tax reform environment, especially if the owners’ ultimate exit strategy involves a sale of their equity in the business.

This article is informational only. You should consult an attorney before acting or failing to act. The law may change rapidly and no warranty is given. LOWNDES DISCLAIMS ALL IMPLIED WARRANTIES AND WITHOUT LIMITATION, ANY WARRANTY OF FITNESS FOR A PARTICULAR PURPOSE. ALL ARTICLES ARE PROVIDED AS IS AND WITH ALL FAULTS. Consult a Lowndes attorney if you wish to establish an attorney/client relationship.

A member of the firm’s tax practice, Amanda Wilson concentrates on federal tax planning and structuring. She represents clients in a wide variety of complex federal tax matters with a particular emphasis on pass-through entities such as partnerships, S corporations and real estate investment trusts.

Specifically, Amanda focuses on advising clients on the formation, operation, acquisition and restructuring of such pass-through entities. In addition, she regularly advises clients on the structuring and operation of private equity funds, real estate funds and timber funds. Amanda is the author of the Bloomberg Tax Management Portfolio 718-3rd Edition, Partnerships- Disposition of Partnership Interests or Partnership Business; Partnership Termination.

Amanda regularly works in structuring deals to benefit from tax advantaged structures, including like-kind exchanges, new market tax credits, low income housing tax credits, qualified opportunity zones, and investment tax credits available for solar and other renewable energy. Amanda also has extensive experience in corporate planning and international tax matters, as well as federal tax controversy. Her practice before the Internal Revenue Service (IRS) includes providing advice on audits and appeals, drafting protests and ruling requests, and negotiating settlements.

Prior to joining the firm, Amanda worked for Sutherland Asbill & Brennan LLP (now Eversheds Sutherland), an Am Law 100 firm in the Atlanta office, where she was part of Sutherland’s Tax Practice Group. Amanda has also served as an adjunct professor at Emory University School of Law where she taught Partnership Taxation.

Amanda regularly contributes to the firm’s Taxing Times blog and is a regular panelist on tax webinars hosted by Strafford Publications.

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