Americans are still scrambling to learn the new rules and regulations under Tax Cuts and Jobs Acts. Likewise, tax and financial planners are looking for new ways to help their clients achieve financial success. One of the new ways is reevaluating the use of C Corporation or S Corporation status for small businesses. Many taxpayers are asking their practitioners which is the better entity structure. The answer to that question is simple – it depends.
Under Tax Cuts and Jobs Acts, C Corporations will have a flat 21% tax rate. This means that no matter how much profit is incurred, it will be taxed at 21%. S Corporations will remain a pass-through entity, with profits being taxed at the shareholder’s individual tax rate (ranging from 10% to 37%). Depending on the type of business and the shareholder’s involvement, S Corporation shareholders may be entitled to a new deduction – the qualified business deduction. Using the following information, we can compare the regular tax incurred between C Corporation and S Corporations:
Example 1: Michael Scott owns 100% of Dumbler Mifflin Paper Company. Michael incurs $50,000 in wages, while Dumbler Mifflin incurs $75,000 profit. Michael is unmarried and does not itemize deductions. Dumbler Mifflin can qualify for a $10,000 qualified business deduction.
| S Corporation (reported on Form 1040) | C Corporation (reported on Form 1120) | C Corporation (reported on Form 1040) | |
| Income | $125,000 | $75,000 | $50,000 |
| Standard Deduction | ($12,000) | $0 | ($12,000) |
| Qualified Business Deduction | ($10,000) | $0 | $0 |
| Taxable Income | $103,000 | $75,000 | $38,000 |
| Tax Rate | 24% | 21% | 22% |
| Tax | $24,720 | $15,750 | $4,560 |
*The total tax incurred under a C Corporation structure would be $20,310.
Example 2: Michael Scott owns 100% of Dumbler Mifflin Paper Company. Michael incurs $50,000 in wages, while Dumbler Mifflin incurs $10,000 profit. Michael is unmarried and does not itemize deductions. Dumbler Mifflin can qualify for a $10,000 qualified business deduction.
| S Corporation (reported on Form 1040) | C Corporation (reported on Form 1120) | C Corporation (reported on Form 1040) | |
| Income | $60,000 | $10,000 | $50,000 |
| Standard Deduction | ($12,000) | $0 | ($12,000) |
| Qualified Business Deduction | ($10,000) | $0 | $0 |
| Taxable Income | $38,000 | $10,000 | $38,000 |
| Tax Rate | 22% | 21% | 22% |
| Tax | $4,560 | $2,100 | $4,560 |
*The total tax incurred under a C Corporation structure would be $6,660.
Example 3: Michael Scott owns 100% of Dumbler Mifflin Paper Company. Michael incurs $250,000 in wages, while Dumbler Mifflin incurs $100,000 profit. Michael is unmarried and does not itemize deductions. Dumbler Mifflin can qualify for a $10,000 qualified business deduction.
| S Corporation (reported on Form 1040) | C Corporation (reported on Form 1120) | C Corporation (reported on Form 1040) | |
| Income | $350,000 | $100,000 | $250,000 |
| Standard Deduction | ($12,000) | $0 | ($12,000) |
| Qualified Business Deduction | $0 | $0 | $0 |
| Taxable Income | $338,000 | $100,000 | $238,000 |
| Tax Rate | 35% | 21% | 35% |
| Tax | $118,300 | $21,000 | $83,300 |
*The total tax incurred under a C Corporation structure would be $104,300.
**Michael’s income is too high to qualify for the qualified business deduction.
There are many different variables considered when choosing between a C or S corporation structure for your business. We encourage you to speak to one of our tax professionals before making any decisions.
