Can Main Street Businesses Just Convert?  No!

Nor Should They.  Here’s why. 

If “corporate-only” advocates have their way and the corporate tax rate is reduced, should pass-through businesses just switch to C status to access the lower rates?   Would that shift improve the tax code and how we treat closely-held businesses?  The answer to both questions is an emphatic no.  Here are the main points:

  • It’s the opposite of tax reform.  Taken as a whole, the corporate-only approach is effectively “anti-tax reform” in that it will return us to the pre-1986 era, when corporate tax rates were significantly lower than the top individual rate and tax shelters and gaming dominated taxpayer behavior.
  • It’s a tax hike either way.  Pass-through businesses that retain their status would pay a top rate of 45 percent.  Those that switch to C status would pay the lower corporate tax, but also be subject to a second layer of tax on their dividends, so their total combined tax would be 48 percent.  It’s a tax hike either way, even with the lower corporate rate.
  • The double tax applies to the sale of closely-held C corporations too.  When a pass-through owner sells their business, they pay the capital gains rate on any gain.  The same treatment applies to shareholders of publicly traded corporations — they pay a single tax at the capital gains rate.  But gains from the sale of a closely-held C corporation are taxed twice, first at the corporate rate and again at the capital gains rate.  Even with the lower corporate tax rate, that combination still means a total effective tax of over 40 percent.

To read the full argument against forcing pass through employers into the C Corp double tax, click here.