Happy holidays — your business just got a tax break! Well, maybe. Congress has passed separate tax bills to fill your business stockings with reduced tax rates and liberal depreciation deductions. Now, we’ll await the final reconciliation, which may be completed prior to the publishing of this article, through the rigorous process of landing on President Trump’s desk for signature.
It’s important to know what you’re getting this Holiday Season from the elves on Capitol Hill. Here are just a few tidbits of tax advice for 2017, and most certainly some discussion points the Bell & Company family will have for our clients early in 2018, as the tax reform begins to take effect. As always, I would caution you to consult with your CPA and tax attorney about any items discussed, as they are most familiar with your own tax and financial situation.
Sunsets from Santa
The last major tax overhaul bill was the Reagan tax bill passed 30 years ago (1986). As a practicing CPA, I’m always leery of tax reform and special provisions, especially the “sunset” provisions whose lifespan is limited due to budget reconciliation concerns. True to form, this tax legislation has a variety of sunset provisions, which add complexity — as opposed to simplifying the tax laws.
No state tax deductions?
The state income tax deduction will be lost, in part, as an itemized deduction for 2018; thus, if you have 2017 state income taxes due, you may want to pay them by Dec. 31. Consult with your CPA or attorney, as the AMT (Alternative Minimum Tax) may reduce your tax benefit. Further, discuss with your advisors whether the tax bill’s non-deductibility of state taxes will apply to state tax paid on business income earned by a pass-through entity in 2018. The bill seems to imply that the deduction may still be available for a sale or state income taxes owed by a business. These situations can lead to further conversations about whether you should file a composite tax return on out-of-state income earned and deduct taxes paid at the pass-through entity level. Is that enough to make your head hurt like you’ve been overindulging the eggnog?
The C-Corp tax rates will be 21 percent, effective for tax years beginning Jan. 1. Most small businesses that Bell & Company serve are not C-Corps; rather, they are pass-through entities such as S-Corps, LLCs or partnerships. The flow thru K-1 income is reported on the individual shareholder or partner’s tax return and taxed using individual taxpayer rates. With the reduction of the highest individual income tax rate to 37 percent, you might think that all S-Corps, LLCs and partnerships would immediately terminate their elections to be pass-through entities and become taxed as C-Corps so as to utilize the tax saving rate differential of 16 percent. The two tax bills in Congress would allow 23-30 percent (now set at 20 percent per the Joint Tax Committee reconciliation), of the pass-through K-1 income to be treated as a tax deduction, reducing the overall taxable rate. Limitations and definitions of what is Qualified Business Income (QBI) may reduce this tax deduction. But you might want to wait to unwrap this gift due to the uncertainty that surrounds the application of the proposed laws
As mentioned, if the 20 percent QBI is fully allowable, is an 8-10 percent differential in tax rates enough difference to change from having your income taxed at the entity versus the individual level? Pass-through entities tax income one time at the individual level. A C-Corp, though taxed at the entity level, would still tax any distributions or dividends to its stockholders or members at the individual rate — which is usually 20 percent. In discussing this with our clients, we have to look beyond the net taxable income amount to their use of the available funds — do the owners leave it in the company for future capital, take a distribution, or a combination thereof?
The gift of increased depreciation?
Finally, consider the effect of the more liberal tax depreciation rules on purchases of equipment and fixed assets for the next 5 years. If you operate a capital-intensive business, such as a trucking company, and you make $750,000 a year, you could in 2018 purchase five trucks and trailers a year to zero out your taxable income and retain your pass-through tax treatment with no stockings full of coal hiding on your personal tax return.
With only a week or so before Christmas, and a little more until the new year, it’s shaping up to be an interesting end to 2017. Regardless of the outcome, it will certainly be a Merry Christmas for my fellow professional advisors, as we finalize year-end tax planning and look forward to what tax reform might bring in the new year.
Happy holidays from Bell & Company.