How the Proposed Corporate Tax Rate Increase Affects Small Business Owners

Sam Brownell was recently quoted in an article from The Business Journals titled “What small-business owners need to know about the potential tax hike”, and wrote this blog post as a follow-up piece with his full thoughts:

There is a lot of concern among small business owners about how Democrats in Congress will pay for their legislative priorities. One of these concerns is the potential increase in the top corporate tax rate from 21% to 28%. However, before you make any decisions, remember that there are many details to work out, so we encourage you to keep up with developments but not to make any abrupt changes to your entity or tax structure until there is more clarity about the final rules. Instead, use the following steps to think strategically about what tax changes will mean for your business.

1. What kind of entity do you own? Remember that a change in corporate tax rates affects C Corporations and those pass-through entities that elect to be taxed as C Corporations. If you own a business that is taxed as an S Corporation, partnership, or sole proprietor, you should pay attention to tax changes such as individual tax rates, payroll taxes, and the net investment income tax.
2. Will there be multiple corporate tax rates? It is our understanding that the new tax regime on C Corporations may not be a one-size-fits-all tax as it is now. Therefore, it will be important for business owners to keep an eye on whether their net income will be in a lower marginal corporate tax bracket. Further, with the proposed increase in both the corporate and top individual tax rates, business owners will need to run scenarios to see whether a pass-through business should continue to be taxed as a disregarded entity or if it should be taxed as a corporation.
3. If you elect to be taxed as a C Corporation, does this election still make sense if the corporate tax rate you pay increases? Business owners don't have to own a C Corporation to elect to be taxed at corporate tax rates. For example, the owner of an LLC may elect to be taxed as a corporation because of the franchise tax that is levied in certain states. For example, many of the independent lumber dealers and hardware stores we work with in the South and Midwest elect to be taxed as C Corporations in order to mitigate these franchise taxes. However, with the change in corporate tax rates, these owners will have to run some scenarios to see if it still makes sense to be taxed as a corporation or if the flexibility of being an LLC allows them to change how they are taxed while continuing to keep taxes below the 28% top corporate rate.

In our opinion, the worst move a business owner can make is to change their financial, tax, and/or operational plan based on what might happen. If you run a good business, keep focusing on what you can control – such as selling more to your best customers – as opposed to what you cannot control. We know that tax policy in 10 years is very likely to be different than it is now. What we don't know is the substance of those differences, and when it comes to taxes, the devil is always in the details. Therefore, in our opinion, keep communicating with your tax and financial advisors but do not make drastic changes to your tax planning until we have more definitive details.