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Evaluating Choice of Entity Decisions in the Changing Political Landscape

While the limited liability company has become the default entity for many business ventures, potential changes to the federal tax rates arising out of the current turbulent political and economic climate may prompt a closer review of your choice of entity decision. Included in many of the pre- and post-election proposals of the current administration, as well as much of the federal legislation currently being debated in Congress, are potential changes to federal tax rates that may impact your choice of entity for current or future business ventures. Scheduled increases in the top marginal individual income tax rate, potential changes to the capital gains tax, a re-examination of the S corporation scheme, and the general uncertainty surrounding health care expense and other payroll taxes increase the complexity and importance of the choice of entity decision. Budget shortfalls have also placed an increased emphasis on enforcement of existing regulations, making decisions such as setting compensation as wages versus distributions, for example, increasingly important.

Some of the potential changes affecting tax rates may change the way we evaluate our entity options. For example, in certain circumstances, if the top individual marginal income tax rate exceeds the top corporate marginal rate, a small business with relatively low earnings electing C corporation status may actually pay lower tax on distributed earnings than an S corporation or partnership/sole proprietorship. Upon the sale of the business via an asset sale, however, the double tax inherent to C corporation status could significantly reduce the amount of distributed proceeds and negate any previous advantage gained from C corporation status. Additionally, these dynamics can change considerably when evaluating a venture with much higher anticipated earnings and/or no foreseeable future sale. Evaluation of the self-employment tax implications of entity selection has also become increasingly important. Exceptions and “exceptions to the exception” for certain activities, such real estate rental activities and real estate dealers, further cloud the analysis.

Even though the final tax implications of much of the federal legislation currently being debated may not be known for some time, a proper understanding of your business objectives and projections, as well as the relevant political issues and potential outcomes, is essential to making the proper decision in your choice of entity evaluation.

To discuss your current or potential business venture and how your choice of entity decision may be affected, contact your Davis & Kuelthau, s.c. attorney.