Tax Reform Strategies for Corporations and Small Businesses
Thanks to the tax legislation bill that lawmakers enacted last year, significant changes to corporate taxation are going into effect in 2018. Corporations and small businesses will have numerous strategies to consider as the new tax rules go into place. Since passage of the Tax Cuts and Jobs Act (TCJA) in 2017, the IRS has provided guidance on some new tax breaks, while elsewhere corrections are needed for glitches in the new law.
Over the summer, business owners of pass-through entities like sole proprietorships, partnerships, LLCs, LLPs and S corporations welcomed guidance on the new 20 percent write-off for pass-through income. Coming in at 184 pages, it’s an extensive read. Here’s a summary of some of the more pertinent strategies we have seen.
Individuals who earn income through a pass-through business can qualify to deduct up to 20 percent of “qualified business income” (QBI) from each pass-through business they own. QBI is the allocable share of income less deductions from the trade or business. QBI can include: rental income if the rental qualifies as a business, income from publicly traded partnerships, real estate investment trusts (REITs), and qualified cooperatives. It does not include capital gains, dividend or interest income, wages paid to S corporation shareholders/guaranteed payments to partners, or business income earned outside the US.
This deduction is significant. For example, a married couple with $100,000 of pass-through income could qualify to deduct $20,000, reducing the couple’s taxes by $4,400 if they are in the 22 percent income tax bracket.
Two limitations for taking this deduction apply to individuals with higher taxable incomes, depending on the types of goods and services produced by the business.
For high earners in specific service businesses including accounting, athletics, health, investment management, and others, a phase-out exists between $315,000-$415,000 if married filing joint or $157,500-$207,500 if single. There is no deduction for owners of service businesses above the phase-out thresholds.
For high earners that run non-service provider businesses with income above $415,000 if married filing joint or $207,500 if single, the deduction is reduced based on a formula of share of W-2 wages and acquisition cost of depreciable business property.
If you are a high earner above or near these thresholds, make sure you are taking full advantage of strategies for deferring or lowering your income.
Even for those making tax-deferred 401(k) and profit-sharing contributions, there may be another tax-deferment vehicle available for use called a Cash Balance Plan. It’s essentially a hybrid between a pension plan and a defined contribution plan. Maximum annual contributions can be substantial, depending on age and income, ranging from $54,000 for ages 30-34 to $256,000 for those 60-65 years old. HSA contributions are another vehicle that can defer taxes to a much smaller extent.
The second tax strategy we will brief is increased depreciation. Under the new tax law, businesses can write off 100 percent of the cost of qualifying assets that they buy and place into service after Sept. 27, 2017, and before Jan. 1, 2023. New depreciation rules apply to new and used asset purchases with lives of 20 years or less. If you are a business owner looking to purchase new qualified assets, the next five years would be an ideal time to do it, provided you plan to take depreciation on that equipment. Starting in 2023 the break phases out 20 percent per year, before expiring in 2027.
One technical glitch in the depreciation rules involves restaurant, retail, and leasehold improvements, which are now characterized as qualified improvement property. Congress fully intended to give QIP eligibility for bonus depreciation, but the law does not reflect this intent. A legislative correction is needed to fix it. If you are a business owner potentially purchasing these assets, it may be worth holding off if convenient in the chance that a fix is introduced.
If you are a business owner, we know you want to know more about this topic. While we will continue to explore details of the sweeping tax changes, we recommend engaging not only with us but with a trusted Certified Public Accountant who can determine how the tax law directly affects you.