Choosing the appropriate type of entity for your business has many factors that should be considered. Tax treatment is one of those considerations, and I have to say, unfortunately there are some business consultants out there doling out the same old advice and assertions that they were using prior to the Tax Cuts and Jobs Act of 2017.
Almost everything in life has a good side and a bad side. The same holds true for business entities. One of the major goals of TCJA was to achieve more parity between the different business structures, see Publication 5318, Tax Reform: What's New for Your Business.
Corporate (C-Corp) income tax rates were lowered from 35% to 21%. Dividends received by shareholders are still taxed at 20%, plus an additional 3.8% for taxpayers subject to the Net Investment Income Tax (if your income is over $200,000 Single or $250,000 Married).
Sole Proprietors, Partners and S-Corp (Flow-Through Entities) may be eligible for a qualified business income (QBI) deduction – also called Section 199A – for tax years beginning after December 31, 2017. The deduction allows eligible taxpayers to deduct up to 20 percent of their qualified business income (QBI).
It is important to note that the QBI Deduction does not apply to amounts received as reasonable compensation from an S corporation or amounts received as guaranteed payments from a partnership.
There is also an Additional Medicare Tax of .9% still in effect that applies to wages (W-2 Income) and self-employment income from either Schedule C or Fm 1065 K-1 Partnership if your income is over $200,000 Single or $250,000 Married.
Distributions from S-Corps are subject to the 3.8% NII Tax mentioned earlier under C-Corps. Also, shareholders of S corporations who work in the business are required to pay themselves reasonable compensation, which is taxable at ordinary income rates. Again, this compensation is not eligible for the QBI Deduction.
Did TCJA achieve the parity it sought? I'm going to provide a real-world comparison of these four different entities and the tax outcomes for the same hypothetical taxpayer under each.