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Editorial 11 MIN READ

The C-corp, reviewed against a 28% proposal

A 21% statutory rate the White House wants to lift, a §1202 window the first TCJA-era shares are about to clear, and a new federal reporting regime that lands on every small C-corp in the country

The Editors
Staff, Incorporator.org
11 min read Updated
Contents 7 sections
  1. The statutory spine, still holding
  2. The American Jobs Plan, read for a C-corp
  3. § 1202 is still untouched, and the first TCJA-era stock is about to clear five years
  4. § 163(j), CARES, and the 2022 ATI ratchet
  5. The Corporate Transparency Act, and why every C-corp needs to track it
  6. What all three do together, to a 2021 formation
  7. Sources

ineteen months after our 2019 field report on the C-corp and a little over three years after the 21% rate took effect, the entity-choice argument has two new inputs: an administration proposal to lift the federal corporate rate to 28%, and a federal beneficial-ownership reporting regime that applies to essentially every C-corp under 20 employees.

Neither has taken effect. Both are close enough that the founder choosing a form today needs to price them.

The statutory spine, still holding

IRC § 11(b) still reads 21%, flat, no brackets. The Tax Cuts and Jobs Act wrote that rate into the Code without a sunset, and the Biden administration's proposal would amend the same subsection. The 21% is what a C-corp incorporated last Tuesday pays on its 2021 taxable income, and it is what every model built during 2018 assumed would carry forward indefinitely.

The first full year of the 2018 Corporation Complete Report from the IRS Statistics of Income Division, released in the second half of 2020, confirmed what the preliminary summer 2019 bulletin had indicated: corporate tax after credits dropped roughly in proportion to the rate cut once you control for the shift in composition, the repeal of the domestic production activities deduction under the old § 199, and the one-time transition tax on foreign earnings under § 965. The 2019 preliminary bulletin, released in late 2020, showed the pattern holding. There is no reverse migration from pass-through into C-corp on any meaningful scale. The 21% rate by itself did not pull operating businesses out of Subchapter S. What it did was make the insurance cost of defaulting to C-corp at formation cheaper to carry, for the companies that were going to raise venture money anyway.

The shareholder-side math is also unchanged from 2018. Qualified dividend rates under § 1(h)(11) remain 0%, 15%, and 20%, and the 3.8% net investment income tax under § 1411 stacks on top for shareholders above the threshold. A dollar of corporate income fully distributed to a top-bracket shareholder still loses roughly 40% federally, state taxes on top. A dollar retained loses 21% and waits.

The American Jobs Plan, read for a C-corp

The administration released the American Jobs Plan on March 31, 2021, and Treasury followed on April 7 with the "Made in America Tax Plan Report" outlining the revenue-raising side. The corporate-tax pieces of the package would:

Restore the statutory rate to 28%, amending § 11(b). Apply a 15% minimum tax on book income for corporations reporting more than $2 billion in financial-statement income. Rewrite the GILTI regime to compute the minimum foreign tax on a country-by-country basis and raise the effective rate. Repeal the FDII export-income deduction under § 250.

The 28% figure matters less for the number itself than for what happens to the distribution math. A fully distributed dollar of corporate income at a 28% rate plus a 23.8% dividend-plus-NIIT bracket loses 1 minus (0.72 × 0.762), or roughly 45.1%. That is back toward the pre-TCJA 50.5% figure, still a few points better, and meaningfully worse than the current 39.8%. State stacks on top in both cases.

The proposal is a proposal. It has not cleared Senate reconciliation instructions, the 28% rate itself is already being negotiated against a 25% counter-offer, and the reported bill that eventually lands could as easily read 25%, 26.5%, or unchanged. A founder modeling a five-year plan should put a probability-weighted rate on the forward corporate line rather than a point estimate, and the realistic band today is roughly 21% to 28%, with the midpoint moving up or down with the negotiation. The planning discipline we laid out in our January 2018 revisit still applies: the § 199A pass-through deduction sunsets December 31, 2025 under current law, and the C-corp rate, whatever it settles at, does not. That asymmetry is the single most important timing variable in entity choice for a company operating past 2025.

What the 28% proposal does not touch, as drafted, is § 1202.

§ 1202 is still untouched, and the first TCJA-era stock is about to clear five years

The qualified small business stock exclusion under IRC § 1202 was not altered by TCJA and is not in the American Jobs Plan as released. For stock issued after September 27, 2010 by a qualifying C-corporation and held for more than five years, § 1202 continues to exclude up to the greater of $10 million per taxpayer per issuer or ten times aggregate adjusted basis from federal gain on sale, at 0% rate, with no alternative minimum tax preference since the § 55 corporate AMT repeal.

The $50 million aggregate-gross-assets test at issuance, the active-business requirement under § 1202(c)(2), and the excluded-industry list under § 1202(e)(3) remain the governing constraints. The excluded list still strikes services broadly, including health, law, accounting, consulting, financial services, and any business whose principal asset is the reputation or skill of its employees. Practitioners have now spent three years papering QSBS memos into formation binders, and the gray-zone questions (software-enabled services, fintech, platform businesses with a human-capital component) have only gotten harder as the case law has stayed thin and IRS guidance has stayed informal.

The forward calendar is what makes this a 2021 story rather than a 2018 story. Shares issued in 2018 by a qualifying C-corp, the first full cohort of post-TCJA formations, begin clearing their five-year holding period on a rolling basis through 2023. Every practitioner we know is fielding questions now about tacking holding periods across § 351 exchanges, about whether to pursue partial § 1202 claims on fact-patterns near the excluded-industry line, and about stacking exclusions across family-member and trust holders under § 1202(b)(3). Those are live 2022 and 2023 filing questions; they are 2021 planning questions.

The second-order effect of the 28% proposal on § 1202 is to make the exclusion more valuable, not less. A higher corporate rate raises the tax on earnings retained inside the entity and raises the capital-gains savings at exit, because a non-qualifying sale would pay 23.8% on gain while a qualifying sale pays 0% on the same gain at the same holding period. The spread widens. If the 28% rate passes and § 1202 stands, the venture-bound founder case for a Delaware C-corp gets stronger, not weaker. The services-business case that belonged in a pass-through still belongs there.

What a rate increase without offsetting § 1202 changes also does is raise the intensity of attention the provision gets. Every revenue estimate of a corporate rate increase prices the § 1202 interaction implicitly, and the legislative history on corporate provisions that the Joint Committee on Taxation staff is producing for the reconciliation process this year will be the first plain-text acknowledgement of how much revenue the QSBS exclusion is now costing. A future administration or Congress may revisit the 100% tier. For now it is intact, and any founder with qualifying stock in the ground should file on the schedule § 1202 sets, not on the schedule a future bill might.

§ 163(j), CARES, and the 2022 ATI ratchet

The § 163(j) interest-expense limitation we flagged in 2018 and revisited in 2019 has taken one round trip since. The CARES Act, enacted March 27, 2020, temporarily increased the adjusted-taxable-income cap from 30% to 50% for tax years beginning in 2019 and 2020, and let a taxpayer elect to use 2019 ATI for the 2020 year, as relief during the pandemic downturn. For 2021, the cap is back to 30%.

The ATI definition is scheduled to tighten anyway. For tax years beginning after December 31, 2021, under § 163(j)(8)(A)(v) as enacted by TCJA, depreciation, amortization, and depletion stop getting added back to compute ATI. ATI moves from an EBITDA concept to an EBIT concept. Any C-corp with meaningful capex and meaningful debt is running numbers on the 2022 transition right now. A growth company with a heavy depreciation line that is currently comfortable under the 30% cap will tighten; a leveraged buyout structure that was uncomfortable in 2019 will get less comfortable.

None of this changes the form choice at the margin. It does change the financing mix a C-corp should run, and it compounds with the 28% proposal in a predictable direction: higher rate, narrower interest deduction, more pressure to capitalize with equity rather than debt.

The Corporate Transparency Act, and why every C-corp needs to track it

The Corporate Transparency Act was enacted as Section 6403 of the William M. (Mac) Thornberry National Defense Authorization Act for Fiscal Year 2021, which became Public Law 116-283 on January 1, 2021 after Congress overrode a veto. The substantive reporting regime is codified at 31 U.S.C. § 5336.

What the statute does, in plain terms: every "reporting company" must file with the Financial Crimes Enforcement Network a report identifying each beneficial owner, defined as any individual who exercises substantial control over the entity or owns or controls at least 25% of the ownership interests, along with the applicant who filed the formation papers. The report collects the individual's name, date of birth, residential or business street address, and a unique identifying number from a government-issued document.

A "reporting company" is any corporation, LLC, or similar entity created by the filing of a document with a Secretary of State, with 23 statutory exemptions principally for entities that are already federally regulated and disclose elsewhere, including most SEC-registered issuers, banks, credit unions, registered investment companies and advisers, insurance companies, and large operating companies (those with more than 20 full-time U.S. employees, more than $5 million of gross receipts on the prior-year return, and a U.S. physical office). A newly formed startup C-corp with three employees is squarely within the reporting population.

FinCEN published an Advance Notice of Proposed Rulemaking on April 5, 2021 at 86 Fed. Reg. 17,557, soliciting comments on the scope, content, and filing mechanics of the reporting rule, with comments due May 5. The final rule is not yet out. Treasury is statutorily required to issue final regulations no later than January 1, 2022, and the reporting obligation applies to entities formed after the effective date of the final rule. Existing entities are on a two-year clock from that effective date to file their initial report.

For entity-choice purposes the practical effects are three.

The filing burden is modest in absolute terms and nontrivial in the aggregate. A small C-corp will file an initial beneficial ownership report and update it within a defined window after any change in beneficial ownership. The cost is administrative, not tax. Outside counsel and registered agents are already quoting packages for ongoing BOI maintenance.

The privacy posture of formations in states chosen for anonymity (Wyoming, New Mexico, Delaware in part) is about to compress. A federal database of beneficial owners is not public. It is accessible to law enforcement, to financial institutions for customer due diligence with customer consent, and to certain foreign authorities on request. What it removes is the ability to form in a state that does not ask who the member is and to be confident that no federal agency has the name. The state-law anonymity pitch still blocks commercial counterparties and civil plaintiffs from finding owners through public records. It no longer blocks FinCEN.

The willful-non-filing penalties under the statute are stiff. Civil penalties run up to $500 per day of violation, capped at $10,000, and criminal penalties of up to two years' imprisonment are available for willful violations. The population that will be caught by enforcement is not the garden-variety operating C-corp that files late. It is the shell operator who fails to file at all, and any operating company that accidentally drops a filing after a change of control. Calendaring BOI updates is about to be a line item on every operating agreement review.

What all three do together, to a 2021 formation

The defaults have not moved. A venture-bound founder still belongs in a Delaware C-corp on day one, and the three-year track record under 21% has only strengthened that argument. A cash-flow services business distributing its earnings still belongs in a pass-through and will still be there through the 2025 § 199A cliff, after which it will reconsider.

What has changed is the ambient uncertainty. In January 2018 the forward five-year horizon was a 21% rate, intact § 1202, and no federal reporting regime. In April 2021 the forward horizon is a rate negotiation between 21% and 28%, intact § 1202 (for now), a § 163(j) ratchet scheduled for next year, and a federal reporting regime whose final rule is not yet written. A founder who needs a decision today has two honest options: model the venture case at the higher end of the rate range and accept that the case still works, or pick a pass-through if the business is a services cash-flow one and accept that the 2025 cliff is coming. The middle case, a profitable operating software company reinvesting heavily, is the one that the rate negotiation will actually move. Its owners are the population with the most to gain from watching the bill text carefully.

The 2016 original made one argument: pick the C-corp if you are building something an investor will underwrite, pick something else otherwise. The bill that set the 21% rate, the bill that left § 1202 alone, the bill that added § 163(j), and the bill that created the CTA all sit on top of that argument without dislodging it. The question a 2021 founder is asking is not whether to pick a C-corp. It is whether the choice they make this quarter is robust to the bill Congress passes this fall. For most companies, it is. For a few in the middle, it is close.

Sources

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