2018 Tax Changes to Ohio BusinessesOhio is already a very business friendly state with the small business deduction allowing individual business owners to deduct 75% of their first $250,000 in business income (up to $187,500). Now with the 2018 Tax Cuts and Jobs Act lowering the corporate tax rate to 21%, many Ohio business owners may be wondering if it now makes more sense to organize their businesses as C Corporations (subject to the 21% tax rate) or as a pass through entity (such as a sole proprietorship, partnership, or S corporation). Pass through entities are called "pass through" because the income of the business "passes through" any taxation at the corporate level and the income is recognized as the owner's individual income, which is taxed at the individual tax bracket level.
Do Pass Through Entities Still Have Tax Advantages Over C Corporations?The short answer is yes. Although corporations organized for tax purposes as "C Corporations," now get a 21% tax rate, C corporation owners still get "double taxed." This means that the corporation itself gets taxed on all net income at the 21% tax rate, but any net profit remaining after tax is still left with the company itself. In order for the owners of C corporations to actually get any of that money themselves, the money is passed from the company to the owner in a number of possible ways: (a) as wages; (b) distributions; or (c) dividends. Ultimately, when the business owner gets that money they have to pay individual income taxes on all money received from the business. That same stream of money already had the business itself pay income taxes on it, and then the owner also has to pay income taxes once they personally receive the money as income. C corporations are double taxed, first at the corporate level, and then second at the individual level.
Pass Through Corporate Entities Receive Additional Deduction Advantages in the 2018 Tax ActIf you've contemplated forming a corporation or changing your corporate structure to a C corporation now that the tax rate of 21% is lower than your individual tax rate, then you would be missing some of the advantages of being structured as a S corporation, partnership, or sole proprietorship in Ohio. Along with the new tax act came new deductions for pass through entities. Although the specifics of the deduction for Qualified Business Income of pass through entities contained in Section 199A of the Act is complicated, the long and short of it is that pass through entities are eligible for up to a 20% deduction of Qualified Business Income. This means that if your small business made $100,000 in net profit, then you could deduct up to $20,000, and then only have to pay tax on $80,000. This still maintains a significant advantage over the C corporation tax rate which would undergo a 21% tax on that same $100,000, and then once those corporate profits were transformed into personal income of the owners, that owner would pay their regular individual income tax rate.
Accordingly, Congress specifically designed the new tax act to maintain tax advantages for pass through entities. There are also some carve out exceptions to the 2018 deduction for pass through entities. In essence, the exceptions are designed to close any possible loopholes for people to be able to game the system by creating pass through entities to get a lower tax rate than they would have received if they were an employee receiving a W-2.