San Diego corporate attorneys provide assistance in structuring companies using the appropriate type of business entity to secure protection from liability and to reduce tax burdens by the corporation and by shareholders.
Tax reform proposals put forth by the U.S. House of Representatives and by the U.S. Senate both propose modifications to the corporate tax rate which might necessitate a change to your business structure. Gehres Law Group can provide assistance in understanding the implication of tax reform on the decisions your company must make about whether to operate as a C-corporation, an S-corporation, or another type of business entity.
How Tax Reform Could Incentivize the Creation of Pass-Through Entities
When a company is organized as a C-corporation, the company pays taxes on profits. Shareholders also pay taxes when profits are distributed, which means some corporate income is double-taxed. Pass through entities work differently. When a pass through entity like an S-corporation is formed, the S-corp does not pay taxes on income the company earns. Instead, profits and losses “pass through” to owners and shareholders declare profits and losses on personal tax returns. S-corp income is thus taxed at the tax rate of the shareholder who declares that income on his tax return.
As part of initial tax reform proposals, President Trump indicated he wanted to lower the corporate tax rate applicable to C-corporations. However, the president also wanted pass-through income from S-corps and other pass through entities to be taxed at the lower rate as well.
President Trump indicated he wanted to lower the corporate tax rate to 15%, including for S-corporations. Because many S-corp owners have a significantly higher personal tax rate than 15%, this would amount to a substantial tax cut for any shareholders with a higher tax rate. This proposal from President Trump was viewed as a loose framework for House and Senate republicans to put forth their own tax reform plans, but each plan was expected to include changes to how pass-through income is taxed along, with other modifications to the corporate tax code.
Bloomberg reported, before the tax reform proposals were formally released, that proposals to modify the pass-through rate would create a “pass-through boondoggle,” by changing the current system and introducing added complexity through offering a different lower-tax rate for pass-through owners. A strong incentive would be created for anyone with a tax rate above the new lower rate to form S-corps and earn as much income as possible through these organizations to be taxed at the lower rate. According to Bloomberg, “to keep other people who make lots of money from shifting their income into these vehicles to take advantage of the 25 percent rate, Congress will have to “adopt measures,” whatever those might be.”
The tax reform proposals have been released now, and both do include important changes to how pass-through income is taxed. According to the Washington Post, the House plan contains a complicated rule permitting 30% of pass through income to be taxed at the 25% rate that the House proposed for the new corporate tax rate. The remaining percentage of the business income would continue to be taxed at ordinary income tax rates by shareholders. The Senate plan, on the other hand, allows pass through entities to reduce income by 17.4 percent. However, law, engineering, medicine, and financial service companies with higher incomes would not be permitted to take this deduction.
It remains to be seen which plan is adopted or if either initial proposal for changing pass-through income ultimately makes it into law. However, it is clear that with proposed changes to the tax code that could have such a profound impact on how businesses are taxed, many companies will likely benefit from working with our San Diego corporate attorneys.
How San Diego Corporate Attorneys Can Help
San Diego corporate attorneys at Gehres Law Group can provide invaluable assistance with determining how best to structure your business to reduce your tax obligations within the current legal framework. To find out more about how our firm can help you, give us a call today.