There’s a lot of talk in the news and social media about the Trump Tax reform, and it doesn’t look like it’s going away anytime soon. But what does his proposal mean for small business? Here is Charles Read, President, and CEO of GetPayroll and Simon, CPA, and US Tax Court Practitioner's take:
First, it is important that you understand that a corporation is not an entity that consumes anything. A corporation is a “group of people authorized to act as a single entity (legally a person) and recognized as such in law.” It is a fictitious person under the law. But yet it consumes nothing. It doesn’t go to the doctor, take drugs, eat, sleep, have children, or any of the things that people do that consumes money or other assets. Corporate taxes are simply a way for the government to collect tax revenue without raising it from the citizens. In return, corporations raise their prices to cover the tax cost.
The Effect on S-Corporations
Most small businesses learn early on, usually from their CPA, what an S-Corporation is, and why they should be taxed as one if they are incorporated or are an LLC. The designation comes from making an election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code. It allows a corporation to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. Shareholders of S-Corporations report the flow-through of income and losses on their personal tax returns and pay tax at their individual income tax rates, allowing S-Corporations to avoid double taxation on the corporate income.
So, what kind of changes to S-Corporation taxes would the Trump proposal entail, including reducing the top corporate rate to 15%?
Let’s take an example of a regular or C-Corporation and an S-Corporation for tax purposes. I am going to make a simple example of total taxation which leaves out some fine points but illustrates what happens.
A regular corporation earns a profit before paying the shareholders $300,000.00 and pays the only shareholder a salary of $150,000.00.
The taxation is as follows:
On the corporation: on Form 1120 the tax is $ 41,750.00.
On the shareholder: have a taxable income on his Form 1040 of $100,000.00 (Salary of $150,000.00 and deductions of $50,000.00) and is a single tax of $21,030.00.
The shareholder takes out the remaining $108,250.00 ($150,000.00 minus taxes of $41,750.00) the taxpayer pays an additional $16,237.50 (15% rate).
Total Tax is $79,017.50.
An S-Corporation in the same situation. The taxpayer has taxable income of $250,000.00 (Salary of $150,000.00 and corporate pass-thru income of $150,000.00 less the same $50,000.00 deductions), and the tax calculated on his Form 1040 is $66,029.25.
In this scenario, the single shareholder owner of an S-Corporation gets a tax saving of $12,988.25 which is 19.7% less than if it were a regular corporation for tax purposes.