The Tax Cuts and Jobs Act of 2017 (the “Act”) lowered the federal corporate tax rate to 21%.
The Act reduced the “C” corporation tax rate from 35% to 21%. Many think this tax break is solely meant for America’s largest corporations-which is not so. But, before a small business jumps onto the “C” corporation “band wagon” consider the following: Are you willing to leave profits in the corporation indefinitely?
Remember, in comparison, an “S” corporation has very lax rules as to distributing funds. These shareholders may usually simply take residual cash/profits without any tax consequences. But a “C” corporation has stringent rules. Taking residual cash/profits from the “C” corporation can create DOUBLE taxation. This is because the entity structure does not allow for tax free distributions like an “S” corporation. If the “C” corporation shareholder pays him/herself residual cash/profits there is generally no corresponding deduction to the “C” corporation (so you have not reduced the “C” corporation tax at all) but you likely will be fully taxed, individually, upon you personally receiving this distribution, as a dividend, usually.
Many times, the tax on this distribution will be at ordinary individual tax rates but with some careful tax planning the tax on these distributions (dividends) can be taxed at individual capital gains rates (from 0% to 20%, albeit most people are in the 15% capital gains bracket). Presuming you have structured this distribution at the 15% capital gains bracket you have effectively, as a small business person, paid a 36% tax on these distributions (21% at the corporate level since there is no deduction to the “C” corporation, plus the 15% personal tax rate you pay as an individual). And if this distribution is not structured under capital gain rates you could easily pay a 22% (the rate many Americans will hover around, personally) personal tax plus the 21% corporate tax, yielding a 43% total tax on these distributions.
Thus, any time funds are paid out of a “C” corporation you should try and be sure there is a corresponding deduction at the “C” corporation level. Paying out bonuses to the owners triggers personal taxes to the recipient, at that person’s individual tax rate but also allows for a deduction at the corporate level. Shareholders may also pay out rents to themselves if the owners use their property for the corporation’s business-again taxable income to the individual and a tax deduction to the Corporation. The key here is to try and balance the competing tax rates. So careful planning is required to try and stay within the personal tax bracket of 22% (up to $82,500 for single persons and $165,000 for a married couple). Once you exceed these personal limits it does not make sense to have more income individually as the corporate deduction is only 21%.