One of the biggest talking points from the recently passed tax law—the Tax Cuts and Jobs Act—is that corporations will enjoy a tax-rate reduction from 35 percent to 21 percent. That14-percent windfall has many hoteliers asking: Should we reclassify as a C-corp?
Paul G. DiNardo, founder of CSG Strategic Tax Consultants, said it’s one of the most common questions he receives from his clients now.
To understand the answer, it’s important to first break down some of the changes that affect the numbers.
Business Pass-Through Rate
Tax-law changes allow for a deduction of up to 20 percent of domestic qualified business income from a pass-through entity, according to DiNardo. This essentially allows for an effective top marginal rate of 29.6 percent.
“This is what is going to benefit individuals in the hospitality business,” DiNardo said during a webinar hosted by the Asian American Hotel Owners Association, titled “How Will New Tax Law Changes Impact the Hospitality Industry?”
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“The 20 percent of QBI is the maximum you can get, and then there are other deductions you have to go through. However, if your taxable income is under $315,000, you don’t have to jump through any hoops; you get the 20-percent rate,” DiNardo said. “If your taxable income is above $415,000, you have to jump through all the hoops. If it’s between $315,000 and $415,000, it phases out.”
If taxable income is greater than $415,000, the deduction is limited to the greater of 50 percent of W-2 wages or 25 percent of W-2 wages plus 2.5 percent of unadjusted basis of fixed assets.
“That’s going to be depreciable assets, not land. If you have a building and you don’t pay any wages, you still get a 20-percent reduction on your QBI limited to 25 percent of your W-2 wages plus 2.5 percent of unadjusted basis of the asset,” DiNardo said.
The deduction also cannot exceed the lesser of the combined QBI amount or 20 percent of taxable income, he added.
Should My Business Become a C-corp?
The short answer is probably not, DiNardo said. Here’s why:
Say your limited-liability company has taxable income of $315,000. The company has business income of $100; add the 20-percent deduction described above and taxable income becomes $80. Income tax is 24 percent, or $19.20. Take the $100 business income, subtract income tax of $19.20 and the net is $80.80. You have a tax rate of 19.2 percent.
Now, let’s look at these same figures under a C-corp, which has a static income-tax rate of 21 percent. The net to the corporation on $100 of corporate income would be $79. But, to get cash out, corporations have to pay a dividend rate. Take 18.8 percent from that $79 and the net to the shareholder is now $64.15. Now, the corporation’s tax rate is 35.85 percent.
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But what if your business has taxable income of more than $315,000? Let’s say, it’s $600,000 or greater. Business income of $100 becomes $80 after the 20-percent deduction. An income tax of 37 percent equals $29.60, or 29.6 percent.
Even though the corporation’s 21-percent income tax rate stays static, the dividend rate taken out is 23.8 percent, which allows the shareholder a net of $60.20 and effectively gives the corporation a tax rate of 39.8 percent.
“The principal reason on this is that in order for you to get the money out of the C-corp is you have to take it out of dividends. If you take it out of dividends, you’re paying a second level of tax,” DiNardo said. “So, even though the corporate tax rate went from 35 percent to 21 percent, the individual effectively went from 39.6 percent down to essentially 29.6 percent.”
That’s why DiNardo said he and his firm recommend maintaining pass-through status, with maybe one exception.
“If I had to create a scenario where it might make sense to be a C-corp, it may be if you have a leveraged buyout,” he said. “If you borrow a ton of money to buy a company and that liability is sitting in the entity, if you were a C-corp and you were going to retain all your profit to pay down that debt and not take any money out yourself, then there might be a benefit to being a C-corp.
“But if we’re just talking about a traditional operating business where you take cash out, you should not think about switching to a C-corp status," he said.