817 / How did the 2017 tax reform impact a business owner’s calculus regarding choice of entity decisions?

Under the 2017 tax reform legislation, C corporations are now subject to a flat 21 percent income tax rate at the entity level and pass-through business income is taxed at the individual level, where a maximum 37 percent rate now applies. While this seems simple on the surface, the true calculus post- tax reform is not nearly so straightforward.

C corporation income must eventually be distributed by the corporation to its owners, where it is then taxed a second time, at the individual level. The rate of tax on corporate distributions depends on how the distribution is classified. If the income is salary, the maximum 37 percent ordinary income tax rate may apply, but the corporation may deduct the payment. If the distribution comes in the form of dividends, a maximum long-term capital gains rate of 23.8 percent (including net investment income tax) may apply and no deduction is permitted. This structure makes dividend distribution more appealing, but even the effective tax rate on dividends creeps up to 39.8 percent when the double tax is factored in. If a sale of the C corporation is contemplated, the double tax issue arises once again.

Pass-through entities may be entitled to all or part of a new 20 percent deduction for qualified business income. The availability of this deduction depends upon the business’ annual income and the type of business in which the entity is engaged. Specified service trades or businesses (SSTBs, see Q ) can only take advantage of the full deduction if income is less than the annual threshold levels plus $50,000 ($100,000 for joint returns).  The applicable threshold levels for 2025 are $394,600 and $197,300 and for 2024 are $383,900 and $191,950.