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January 17, 2018

How will your choice of entity impact your federal business taxes in 2018 and going forward?

Should you be S Corp, C crop, Sole proprietor or a Partnership? The good news is no matter which form of entity you choose, you will pay less in tax on your business income in 2018 and going forward as compared to what you paid in 2017. If your taxable income is $315,000 (157,500 for single filers) or less you might still be better off being an S Corporation, Sole Proprietor or a Partnership.

Why?

Since you get 20% deduction from your net business income with no imitations. You do not pay any tax when you take cash distributions. Compare it to distributions from a C Corporation which is subject to 15% tax.

Example: Jeff has net business income of $100,000 from his S- Corp in 2018. His taxable income is 215,000. He files jointly with his wife. Let’s assume his highest tax bracket is 24%. His tax savings if he has an S Corp will be $1,800(21,000-19,200).

  S Corporation C corporation
Business Income   100,000 100,000
Less:20% deduction   20,000 -
Income after deduction   80,000 100,000
Tax Rate     24% 21%
Tax   19,200 21,000

Further lets assume he took a dividend distribution of $20,000 from his S Corporation. Lets look at its impact if it was an S corporation vs C corporation. A tax savings of 4,800(24,000-19,200).

  S Corporation C corporation
Dividend distributions   20,000 20,000
Tax on Dividends   - 15%
Tax (1) - 3,000
Add: Tax calculated above(2)   19,200 21,000
Total effective tax(1) +(2)   19,200 24,000

If your taxable income is more than 315,000 (157,000 if single filer) your business deduction will be lower of

  • 20% net income from business or
  • 50% of W-2 wages you pay to your employees or
  • 25% of W-2 wages plus 2.5% of basis of Qualified Property
Essentially it is restricted by the amount of wages you pay to your employees. Remember it does not include amounts you pay to outside contractors who are not on W-2. As you can see above the calculations now becomes complicated you must consult your tax advisor to see which form of entity is best for you.

Other factors that affect the choice of entity are

  • State taxes you pay
  • Net Operating Loss Carryforwards from prior years
  • Your personal income other than your business income
  • AMT you pay on your personal income (Corporations don’t have AMT)
  • How much distributions you intend to take each year from your corporation
As you can see above the calculations now becomes complicated you must consult your tax advisor to see which form of entity is best for you in 2018 and going forward.

By Mariya Luqmani, CPA, CA, MST