Pass-through, or corporation?

Business entities in the United States fall into one of two categories: C corporations, or “pass-through” entities like limited liability companies and S corporations. “Passthrough” refers to the fact that the profits from these entities are passed through to the business owner and reported on his or her individual tax return.

For decades, pass-through entities have been the preferred structure for small businesses, in large part because corporate tax rates outweighed individual rates. But the new tax bill changes that calculation.

Beginning in 2019, the corporate tax rate will fall from 35 percent to 21 percent permanently. That’s far lower than most income tax rates for individuals. But the bill also includes a 20 percent deduction for pass-through entities, though the cut is temporary and will expire after 2025.

So which small businesses should consider becoming corporations? Tax professionals say the answer is complicated. For one thing, corporations that pay their owners dividends are subject to additional taxes that could make pass-through entities more favorable. And while the corporate tax cut may be “permanent,” there’s no guarantee it won’t change in future years.

Still, Hamill said it’s likely that New Mexico will see an increase in the number of corporations in coming years.

“It’s a game-changer,” Hamill said.

Hamill explores the passthrough deduction structure further in his column on page 6 in this week’s Outlook.