The Tax Cuts and Jobs Act (TCJA) of 2017 is ushering in some of the most significant tax changes in three decades. In anticipation of these changes, Insero recently held a series of Tax Reform Update seminars. If you weren’t able to attend, here are a few of the key takeaways:
1. Entity Selection
If your business is currently an S corporation or an LLC, changing to a C corporation would allow you to capture the benefits of the new lower corporate tax rate (21% vs. 34% in 2017). If your business is currently a C corporation, changing to an S corporation would allow you to benefit from the new “Qualified Business Deduction”, which is 20% of “Qualified Business Income” (QBI).
While there is no “one size fits all” solution, here are some things to keep in mind:
Tax Rate Analysis
When considering the new 21% tax rate, a pass-through entity is no longer a “no-brainer” in many situations. You’ll want to consider the personal tax rate, taking Qualified Business Income (QBI) in to account. For some existing C corporations, a flat 21% may actually result in a tax increase. Here are some key questions for business owners:
- Does the business owner require or want access to business cash? If so, when and how much?
- Will the corporation be reinvesting its profits?
- What are forecasted profits?
- What is the business owner’s sell window?
- What is the perceived ability to sell stock?
Qualified Business Income
New Code Section 199A provides for a deduction equal to 20% of the QBI of pass through entities, including sole proprietorships. There are many limitations, pitfalls, traps, details, and unknowns associated with this deduction, so it is very important that business owners discuss the impact on their business with their service providers. QBI is defined as income or loss from a “qualified” trade or business from US source operations (not foreign). It is NOT wages, salary, guaranteed payments, or investment income. A “qualified” business or trade is defined in the negative, as anything that is not a “specified service business” (SSB). An SSB is one that involves the performance of activities including health, law, accounting, actuarial sciences, performing arts, consulting, athletics, financial services, investment management, or any business whose principal asset is the reputation or skill of one or more of it’s employees. This is by no means a comprehensive list, and the new law leaves much to be defined, so we recommend you discuss your specific situation with your accountant to determine if your business qualifies.
2. Accounting Methods
Assets placed in service after September 27, 2017 now qualify for 100% bonus depreciation until 2022. This now includes used property and pretty much anything other than buildings such as office equipment, machinery, fleet vehicles, and many leasehold improvements. For property placed in service in taxable years beginning after December 31, 2017, the Section 179 Deduction limit is now $1,000,000 (up from $5,000 previously) with phase-out over $2,500,000 (up from $2,000,000). Bonus Depreciation and Section 179 are NOT the same, so we recommend you discuss the differences and benefits with your accountant.
A Cost Segregation Study (CSS) is another option for new buildings (within the past seven to eight years depending on size) and is essentially depreciation on steroids. If you have recently built or purchased any new buildings in the past several years, a CSS could provide your business with valuable tax deductions and increase tax flow.
Cash Method vs. Accrual Method
Under the TCJA, businesses can now use the cash method of accounting, even if you have inventory. You must still “account” for the inventory, but not receivables and payables. C Corporations now have the expanded ability to use the cash method as well. Depending on your type of business and business operations, this may be beneficial and can possibly exist for retroactive tax planning.
3. Personal Taxation
There have been sweeping changes to nearly all facets of personal taxation. There are still seven tax brackets, but each bracket rate has been reduced by two to four percentage points and each bracket has been “elongated”, i.e. a lower rate will apply to more taxable income. The standard deduction has also increased for all taxpayers, while State and Local Tax (SALT) Deductions have been limited to a total of $10,000 (including Income and Property Tax). In addition, the Alternative Minimum Tax (AMT), while not repealed, has been declawed.
What does this mean? New York State Taxpayers with between $100,000 and $150,000 or over $700,000 in taxable income may feel these changes the most. Why? The old AMT and Standard Deduction usually (not always) precluded the benefit of the SALT deductions. However, lower rates will somewhat mitigate this issue.
4. NYS Response to Federal Tax Reform
The Employer Opt-In Compensation Tax program. The idea here is for employers to voluntarily pay a compensation-based tax, for which certain employees would then receive a NYS credit. Presumably, then, the employer would reduce the gross pay of its employees, so that both the employer and the employee stay “whole” on cash flow basis. Essentially the program converts the SALT deduction to less gross income. The program leaves many questions unanswered, which will be interesting to learn about as it is implemented.
What can you do? Get a projection of your 2018 taxable income and tax so that you are not surprised next April, one way or the other. There are very few generalizations that can be made about the overall effect of these changes. The only way to know for sure is to look at your specific situation and put pencil to paper (or fingers to keyboard). Above all, it is important that you get your service provider team on board for any major changes, whether now or in the future. We can work together with your attorneys, investment advisors, and bankers to develop a tax strategy tailored to your specific business situation. Click here to contact us today.
Want to learn more?
Save the date for one of Insero’s Annual Tax Update seminars:
December 11, 2018 in Rochester
December 13, 2018 in Ithaca
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