Clayton & McKervey CPA Poses 15 Questions for Closely-Held Companies Deciding Between a Flow-Through Entity and a C Corp

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Is it better for business owners to organize as a flow-through entity or convert to a C corporation with a better tax rate in light of the Tax Cuts and Jobs Act (TCJA)?

“Before the Tax Cuts and Jobs Act, most closely-held businesses were set up as flow-through entities to avoid the double taxation of C corporations, but now many are thinking of converting because they don’t want to pass up the enticing 21% ‘permanent’ C corporation tax rate,” Biehl said

‘To C or not to C’—that is the question for many business owners—whether ’tis nobler to organize as a flow-through entity with future planning flexibility or convert to a C corporation with a better tax rate. The decision may be tougher than first thought, according to Jim Biehl, a CPA and shareholder at Clayton & McKervey, a certified public accounting and business advisory firm helping growth-driven companies compete in the global marketplace, because many organizations are still grappling with Tax Cuts and Jobs Act (TCJA) changes that have made entity choice a more involved process.

“Before the Tax Cuts and Jobs Act, most closely-held businesses were set up as flow-through entities to avoid the double taxation of C corporations, but now many are thinking of converting because they don’t want to pass up the enticing 21% ‘permanent’ C corporation tax rate,” Biehl said. “What used to be simple is not so straightforward, and may explain why so many companies are opting for a ‘head-in-the-sand’ approach instead.”

Unfortunately, avoiding the inevitable can lead to unintended additional taxes, Biehl said. The number of underlying questions flow-through business owners must address in deciding whether to make the change to a C corporation may seem daunting, but is imperative in helping to make this determination:

1. What is my taxable income outlook?
2. What is the nature and timing of my anticipated capital investments and related bonus deprecation?
3. How much money do I want to pull from the business?
4. Is my compensation reasonable?
5. Impact on foreign income?
6. Do I qualify for the flow-through qualified business income (QBI) deduction?
7. Is the flat 21% C corporation tax rate really permanent?
8. Will the reduced individual tax rates and flow-through QBI deduction be extended beyond 2025?
9. The impact on my Research & Experimentation credits?
10. How many states do I file in?
11. Does the U.S. Supreme Court “Wayfair” decision impact my state tax filings?
12. How do I plan on exiting/selling my business?
13. What is included in my estate plan and could I implement a GRAT or IDIT?
14. Who will be elected President in 2020?
15. Which political party will control the U.S. House and the Senate?

To simplify this process, Biehl suggested a.) prioritizing the four most important questions/assumptions for that business and then modeling the analysis to each particular situation; b.) remembering to review and/or model on an annual basis to address changing needs; and c.) figuring out how the potential change will affect the company’s tax situation, taking into account these four considerations:

  • LLC’s can elect to be taxed as a C corporation.
  • S corporations can revoke the S election by filing a statement of revocation with the IRS.
  • There is a five-year waiting period before a former S corporation can re-elect S status.
  • There is a five-year built-in-gain (BIG) waiting period, after S election, to avoid corporate gain on sale of assets.

“Walking through the assumptions, preparing a modeling analysis and then interpreting the results will help companies decide what makes the most sense for their organization—whether that is staying as a flow-through entity or converting to a C corp,” Biehl said.

About Clayton & McKervey
Clayton & McKervey is a full-service CPA firm helping middle-market entrepreneurial companies compete in the global marketplace. The firm is headquartered in metro Detroit and services clients throughout the world. To learn more, visit claytonmckervey.com.

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Barbara Fornasiero
EAFocus, Inc.
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