The controversial Tax Cuts and Jobs Act signed into law in December 2017 has some new benefits for small businesses that are pass-through entities. Many pass-through entities will now have a new benefit of a 20% deduction relative to profits. The law is touted as being complex, and it is, as it raises many new and interesting issues for advisors. For example, it will be interesting to see what, if any, impact this new deduction will have on the number of small businesses that opt for S-Corp status in order to avoid self-employment tax on “distributions” of profit rather than straight pass-through of profits such as occur in LLCs that are Sole proprietorships or partnerships.
Under the new tax code, a person setting up an LLC can opt to be treated as an S-Corp and, as long as she pays herself a “reasonable” salary, she can legally receive “distributions” of profit without self-employment taxes being assessed. While the salary the S-Corp pays the proprietor is subject to self-employment taxes, the distributions of profit are not. A person setting up an LLC as a sole-proprietor, on the other hand, pays self-employment taxes on all income received from the LLC business.
With this new deduction on the pass-through distributions only (not on the wages portion), the above stated prior benefit of S-Corp status may no longer exist for some. This is particularly true given some of the restrictions that apply to S-Corporations that don’t apply to sole proprietor and partnerships operating as LLCs.
Is this the end of the S-Corp as we know it? Maybe that’s extreme, but It seems that advisors will have reason to weigh the pros and cons even more carefully when helping business owners decide among the options. In truth, only time will tell.
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