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Tax reform pass-through impacts

Should you convert your partnership or S corp to a C corp?

Figuring out how your partnership or S corp will fare under new tax reform laws for pass-throughs may not be an easy task. Deloitte Tax can help you understand this complicated picture, analyze your choice of entity tax considerations, and move forward with confidence.

Choice of entity tax considerations: The topic of a new Bloomberg Tax article

One year after the enactment of tax reform legislation, taxpayers continue to reconsider their historic choice of entity for federal income tax purposes.

Authored by Deloitte Tax specialists Fiona Chambers, Stephen T. Howard, and Meghan C. Lemens, this new Bloomberg Tax Portfolio summarizes the key considerations for pass-through business taxpayers considering conversion to C corporation (C corp) status, highlights a few additional unique considerations, and describes practical tips and next steps once the pass-through entity makes the decision to convert—or not to convert—to a C corp.

Deloitte Tax perspective: Digging into the dilemma for partnerships and S corps

The 2017 Tax Act (the Act)i offers a combination of tax-rate reductions and various tax breaks for C corps and certain owners of certain pass-through entities like partnerships or S corporations (S corp). However, the lack of clarity in the new law leaves many pass-through entities struggling to understand whether they will qualify for such tax-rate reductions and if it even makes sense for them to retain pass-through status.

To convert or not to convert to a C corp is the dilemma many private companies are facing today. Arriving at the right course of action will require more than just modeling. A partnership or S corp must consider the strategy and future of their business, and the potential ripple effects of the new and interrelated provisions. Given the complexity of tax law, the devil is in the details, and business owners have a fiduciary responsibility to vet the matter thoroughly and understand the choice of entity tax considerations.

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Partnerships and S corps should look beyond the math

While the Act lowers the C corp federal tax rate to 21 percent, it also introduces advantages to certain individual and trust owners of partnerships and S corps through a special 20 percent pass-through deduction. However, many business owners will not qualify for the full deduction under tax reform for pass-throughs. In addition, a new cap on state income tax deductions at the individual level ($10,000) may cause state income taxes generated from ownership in a pass-through entity to become 37 percent more expensive because of the limited or lost deductions. These changes leave many partnerships and S corps wondering, Is now the time to convert to a C corp?

At first glance, arriving at the answer may seem easy: Use basic math to quantify the rate differential and the detrimental impact of limited state income tax deductions by individual shareholders. But there are other factors to be considered.

Qualitative choice of entity tax considerations

Understanding how to proceed with considering a conversion from a partnership or S corp to a C corp starts with knowing how the business and its owners are being taxed at an individual level, understanding how the business accrues value, and projecting its ultimate exit strategy. And this means asking a series of foundational and qualitative questions including, but not limited to:

Moving your entity conversion decision forward

With the right approach and support, understanding tax reform for pass-throughs and analyzing your choice of entity tax considerations doesn’t have to be a painstaking process—but it should be a thorough one. It may be beneficial to go through this process up front—determine whether a conversion is right for your business and understand what it’s going to take internally to make the most of it.

iAn Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.

Related tax reform insights for private companies

The lower corporate tax rate and related provisions in the tax reform law are likely to cause shifts in your competitive landscape and spur new interest in M&A opportunities. Learn more about the evolving deal-making environment and what it means for your business in Tax reform for private companies: Is now the time to sell?

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