The $1.5 trillion federal Tax Cuts and Jobs Act, signed into law late last year, was widely viewed as a big win for businesses,
but that doesn’t mean it is simple.
While the law broadens and lowers tax rates across the board, obtaining those tax advantages for most businesses will require some planning and forethought.
“Accountants, like attorneys, love change and this is definitely keeping our phone ringing and us busy,” says Scott Cress, a director at the Barnes Dennig CPA firm based in Cincinnati. The new tax law, which took effect Jan. 1, 2018, “creates a tremendous amount of planning opportunities. [But] if you don’t pay attention to your metrics you can end up with unintended consequences.”
He says it is important for businesses to talk to their accounting firm to make sure they’re taking full advantage of the new law’s provisions.
“It’s certainly the largest overhaul of the tax code in a long time,” says Scott Eichar, senior tax manager at GBQ Partners LLC in Columbus.
“The bottom line is don’t wait until the end of year for tax planning,” he says. “We really advise that taxpayers reach out to their tax adviser and at a minimum look at their 2018 situation based on their 2017 filing to see what the impacts are to them.”
Most of the headlines late last year were around the laws replacing the graduated corporate tax structure of four brackets up to 35 percent with a single corporate tax rate of 21 percent.
“This wasn’t meant to be any kind of stimulus to small businesses. It was about getting the corporate rate down,” Eichar says. The corporate tax rate cut is permanent, but most of the law’s other provisions are slated to expire at the end of 2025.
The new law retains seven personal income tax brackets, but most of the brackets have been lowered. For example the top bracket of 39.6 percent under the old law is now 37 percent.
In addition, Eichar says, “It takes more income than before to be in the top rate than it did before.”
The new law also didn’t forget individuals who receive business income from pass-through entities. The law creates a new 20 percent deduction for the qualified business income reported by such entities through 2025.
Most small businesses operate as income pass-through entities (such as sole proprietorships, partnerships and limited liability companies).
“There are more than 40 million pass through returns filed each year and that doesn’t include Schedule C filings [on personal returns]. That’s a big deal to a lot of businesses,” says Eichar.
“In simple terms if you had businesses generating $100,000 in profits flowing to you on Schedule C or a partnership, you’d be able to take a deduction of $20,000. You’d only be taxed on $80,000,” says Eichar. “If you were subject to the top individual tax rate of 37 percent that brings the top rate down to 29.6 percent.”
There are some limitations on that 20 percent deduction for pass-through business income. Some specific service industries such as health, law and professional services are excluded and there are limits for those married filing jointly with incomes above $315,000 and single fliers with income above $157,500.
The deduction also only applies to qualified taxable income.
“If for some reason your taxable income was only $50,000,using the prior example, you could only claim 20 percent of $50,000 not of the full $100,000,” he says.
The $20,000 deduction was designed to help level the playing field with the lower 21 percent corporate tax rate, accountants say.
But some pass-through businesses have wondered if it makes sense to convert their pass-through business structure to a regular “C” corporation to get the more favorable 21 percent tax rate.
“One of the things that’s kept us most busy with this tax law is taking a really hard look at corporate structure for our clients. They’re asking does it make sense to convert to a ‘C’ corporation or not?” says Cress.
“It’s not a slam dunk,” he says. “I could have multiple businesses and similar metrics and I’m going to have a different recommendation to go ‘C’ or stay an ‘S’ corporation depending on a number of different things.”
One problem, he says, is that it’s not easy to bounce back and forth from one structure to another.
“You have to stay put for at least 5 years after you make a change one way or another,” he says.
Another big change for businesses is an increase in the amount they can expense on taxes.
Businesses can now expense most capital improvements such as furniture, fixtures and equipment up to $1 million a year, twice the $500,000 limit in the old law.
“So to the extent a business has a lot of heavy machinery or computer purchases or any fixed asset purchases, the amount is doubled,” says Eichar.
“In addition, we now have 100 percent bonus depreciation that’s unlimited. It will start to phase out 20 percent a year in five years but for now it can be used on the purchases of new or used property.”
Additionally, the bonus depreciation is for any property purchased after Sept. 27, 2017, one of the few features in the new law that’s retroactive.
“I think we’ll see lot more businesses buying equipment. I think it will be a windfall for those that sell business-to-business products and that sort of equipment,” Cress says.
One downside is that it will also likely mean higher prices because of the increased demand, he says. The bonus depreciation feature also doesn’t extend to real estate purchases.
One of the biggest changes in personal deductions is that itemized deductions for state and local taxes is limited to $10,000 under the new law. In addition the standard deduction has increased to $12,000 for individuals and $24,000 for married couples filing jointly.
For many married couples the increase in the standard deduction will cancel the benefit of itemizing since their mortgage interest and state and local deductions combined won’t exceed $24,000.
As for the handling of meals and entertainment expenses under the new law, the good news is that the annual holiday office party is still 100 percent deductible. The bad news is that the 50 percent deduction for client entertaining expenses has been eliminated.
Overall, Cress says, “Most of my clients are excited. I think this is a pro-business tax reform.” It’s not universal though. “High-wage executives in high-tax states might potentially end up paying more tax,” he says. “I have some pro-athlete clients who are probably going to end up paying more tax because they lose the benefit of all their miscellaneous itemized deductions.”