Tax implications and consequences weigh heavily on companies when making strategic business decisions. Among the most important decisions to make is also among a company’s first, and that is choice of entity. The most common entity options include: limited liability company, corporation, or partnership. Each option presents different benefits and drawbacks, and many companies will choose the best option for their specific circumstances. Such considerations include liability status, management structure, and corporate formalities required by the home jurisdiction. Another consideration for future or current entities is the tax implications of their decision.

Different entity types provide different tax structures which often heavily influence entity formation decisions. For instance, partnerships and S corporations are “pass-through” entities because their income is included in the owner’s gross income, and is not taxed at the corporate level.[1] On the other hand, C corporations experience “double taxation,” meaning that the entity pays the corporate tax rate, and when the C corporation distributes earnings to shareholders as dividends, the dividends are taxed at the shareholder level.[2] The federal government, through the tax code, often plays a further role in directing entity formation decisions via favorable rates for some types of entities over others. As a result of changing federal tax codes, there have been waves and trends over time regarding choice of entity. Many of the most significant changes to the federal tax code in years occurred recently as a result of the 2017 Tax Cuts and Jobs Act.[3]

Historically, mostly prior to 1986, C corporation tax rates were lower than individual rates, and as a result C corporations were more common than S corporations and partnerships combined.[4] Through the tax code, the federal government was favoring the formation of corporations. Following the 1986 Tax Reform Act and steep decrease of individual tax rates, many more S corporations formed and many other entity types converted to S corporations.[5] . Specifically, the number of registered C corporations has actually fallen by roughly 1 million since 1986, whereas S corporations have grown from 826,214 to 4,380,125 in 2014, and other pass-through entities (partnerships and LLCs) have grown from 1,702,952 to 3,611,255.[6] As of 2017, the maximum corporate tax rate was 35%, and that plus the maximum individual dividend rate equated to about 50% of corporate income, which is significantly higher than the maximum flow-through rate of 39.6%. These rates help explain why flow-through entities were much more popular in the last few decades compared to C corporations, and also shows how powerful the federal government’s tax rates can be in dictating the decision entrepreneurs and business owners make when deciding what entity to form as.

One can expect a similar effect as a result of the 2017 Tax Cuts and Jobs Act, which again significantly altered tax rates within the corporate sphere. For all previous brackets the corporate tax rate will be 21%, with a dividend rate of 23.8%, which is much closer to the individual rate of 37% than it historically has been.[7] Additionally, the new tax bill has introduced many new business deductions available only to corporations, such as state income taxes.[8] Overall, the lower corporate tax rate is meant to spur the formation of US corporations, as well as preventing jobs from moving overseas.[9]

While these benefits apply to C corporations, many additions and revisions to the tax code are also targeted at pass-through entities. Firstly, while the top individual income tax bracket is 37% (a slight reduction from the previous 39.6%), this can be reduced to 29.6% by way of a 20% deduction for certain qualified business income.[10] The 20% deduction is subject to many limitations and qualifications that should be explored in detail in § 199A of the tax code. Additionally, the standard deduction has increased, and for individuals it has increased from $6,500 to $12,500.[11]

Overall, it is unclear whether the new tax provisions will lead to significant growth in one entity form compared to the others; particularly C corporations versus pass-through entities. Whereas 1986 the tax changes lead to a significant increase in pass-through entity formation for three decades, the 2017 Tax Bill has brought beneficial changes for both C corporations and pass-through entities. The reduction in the corporate tax rate will certainly be welcome for existing C corporations, and the rate reduction may lure new entities to form as C corporations. However, the 20% qualified business income deduction available to pass-through entities is also attractive for entrepreneurs. However, one must be sure that they meet the requirements and restrictions set forth in the tax code.

Nevertheless, despite the lower tax rates for C corporations, I would argue that one can expect the downward trend in registered C corporations to continue. Especially for young startup companies, the requirements, restrictions, and fees imposed by state corporate law can be overly burdensome. Additionally, the ability to convert to another type is always an option, and therefore the flexibility provided by the LLC is hard to argue against in most situations. If you are forming an entity and have questions regarding the tax implications of your choice, consider contacting a licensed tax attorney or public accountant, especially in light of the 2017 tax changes.


[1] Michael Graetz, Deborah Schenk, and Anne Alstott. Federal Income Taxation. Foundation Press, 8th ed. 2018, 532

[2] Graetz, 532

[3] Graetz, 531

[4] Graetz, 532

[5], 82

[6] Joint Committee on Taxation, Present Law and Data Related to the Taxation of Business Income, JCX-42-17, September 15, 2017


[8] Graetz, 535