Provisions of the Tax Cuts and Jobs Act of 2017 are expected to end as of Dec. 31, 2025. That could mean a big tax increase for owners of subchapter S corporations. The current top federal income tax rate on pass-through business income is 29.6 percent. If Congress doesn’t act, the rate will revert to the pre-TCJA rate of 39.6 percent.
Not surprisingly, a lot of conversations are popping up about whether it makes sense for the owner of a Sub S business to change to a C corp, where the federal income tax rate is expected to remain 21 percent.
Obviously, the difference between a 39.6 percent rate and a 21 percent rate is substantial. But, that doesn’t mean you should abandon your Sub S structure, if you have one in place now. Dividends are taxed as much as 23.8 percent. So, the double taxation on the corporation’s earnings might make the total tax hit higher than it would be in the Sub S scenario.
One of the key considerations is the intent of the business owner. If you expect to leave earnings in the bank as a way of building capital, then the C corp route might make sense. But, if your goal is to return those earnings to shareholders, then the Sub S structure may be worth preserving. Keep in mind, there are state taxes to figure into this equation, as well.
Here’s something I think really needs to be considered. That 21 percent corporate tax rate, while seemingly “permanent” now, may change. Regardless of the outcome of the election, one could make a reasonable bet that there is some tax restructuring coming, and it’s no stretch to assume it would include the corporate tax rate. And we know if the rate is changed, it’s not going down.
I have always liked the Subchapter S structure, and over the years its benefits have varied with changing tax rates. But in the end, double taxation is so unappealing that I think it is very difficult to make the case that it is best to go back to a C corp. If you are wondering what’s best for your situation, I highly encourage you to contact your tax advisor. There are several excellent accounting firms that specialize in banks that advertise with this magazine, and I encourage you to visit with any of them.
