To avoid this issue, consider splitting up a business into its constituent parts. For example, one of Lieberman’s high-income clients has a company that does both manufacturing and consulting. So that the client can deduct the profits of the manufacturing arm, it’s going to be spun off into a pass-through entity by itself. With the new law, “advisors need a better understanding of their clients’ businesses,” Lieberman says.
Big Decision
Many clients will want to know which is better for them, a C corporation, bearing in mind that its profits are taxed first at the 21% corporate rate and then again to the owners when they take out the earnings as dividends, or a pass-through business with its potential 20%-of-profits deduction and no double taxation.
Owners who plan to sell their companies soon, or who take out the earnings each year, may fare better with a pass-through to avoid double taxation, says Haller, the Long Island CPA.
On the other hand, owners seeking to reinvest their enterprise’s profits may find a C corp more attractive, although they need to be serious about reinvesting, i.e., ramping up inventory, making capital expenditures and strategic acquisitions, and so forth, says Haller. Otherwise, the corporation could get slapped with the nefarious accumulated earnings tax on profits retained beyond the reasonable needs of the business, he warns.
But for the right owner, a C corp could be a home run. Tom Wheelwright, a CPA and founder of Tax-Free Wealth CPAs in Tempe, Ariz., has a client in expansion mode who plans to switch from a pass-through to a C corporation. “He’s looking at writing off all the equipment for the expansion as bonus depreciation, taking a Section 179 deduction for improvements, and paying 21% on whatever’s left as profit. This is a business with millions of dollars of net income, but it will not owe much tax in the foreseeable future,” Wheelwright says.
Given the presumed permanence of the 21% corporate rate and the temporary life of the deduction for part of a pass-through business’s profits, as well as a decrease in bonus depreciation after 2022 and other changes and considerations beyond the scope of this article, “Tax advisors will have to run numbers for several years forward to help clients make good decisions,” Wheelwright says. “It’s going to take some pretty good analysis.”