Tax Law
Dear Readers,
We have received several questions about the new tax reform law enacted at the end of December 2017. The Tax Cuts and Jobs Act provides the most comprehensive update to the tax code since 1986 and includes a number of new provisions. We sat down with Travis Truesdell, CPA, of BKD CPAs & Advisors, to try to get to the bottom of the tax implications for business owners. Travis has spent the past 10 years in the tax industry focusing on commercial clients, particularly in the construction, real estate and hospitality industries. The question discussed today is: What implications does the new 2018 tax reform law have on small local businesses?
Pedro: This is a great question….and I’m glad we have a tax advisor here to help address it! Travis, what are your thoughts?
Travis: I think one of the first questions that a business owner should ask is “Can I take advantage of the qualified business income deduction (also referred to as the QBI deduction)?” QBI is defined as the net amount of domestic business income, gain, deduction, and loss with respect to any qualified trade or business. Non-corporate taxpayers receiving QBI from a partnership, S corporation or sole proprietorship could benefit from a deduction of up to 20% of this income. Like any tax law, there are limitations to these general rules when taxable income exceeds certain thresholds, including limitations based on W-2 wages paid, but primary intention of this QBI deduction seems to be to keep the tax playing field as neutral as possible, regardless of how you have chosen to structure your business.
Josh: Are there tax benefits or at least tax implications for how a business is structured?
Travis: Yes. Another common business structure is to incorporate the business, which is really easy to do. An incorporated business by default is taxed as a C corporation but can also be taxed as an S corporation if the proper steps are taken. An S corporation is considered a "pass-through entity," which means the business itself is generally not subject to tax—similar to a partnership. Instead, income from the business is reported on a Schedule K-1 to the business owners who then use this information to report their share of business income on their personal tax returns and pay tax on this income at individual income tax rates. Under the new tax law, the top federal income tax rate at the individual level is 37% until 2026. In comparison, C corporations directly pay tax on the business income generated and, under the new tax law, are subject to a flat federal income tax rate of 21%. In addition, dividends paid to shareholders are generally taxed at a top tax rate of 23.8% (i.e. double taxation). This all means that incorporating your business as an “S Corp” could possibly save you a lot of money. Keep in mind that owners of pass-through entities would potentially be eligible for the QBI deduction, which helps bridge the gap in tax rates. There are many other factors to consider when determining how to structure your business beyond just the tax rates—such as when you might want to sell your business and if you plan to take money/profits out of your business—so finding the right advisors to assist you in the structure decision process is critical.
Business owners have several options when considering how to structure their business. A common structure that I see in practice is the formation of a limited liability company (LLC). An LLC is generally taxed as a partnership, but can also be taxed as a sole proprietorship or even as a corporation (S corporation or C corporation) if the proper steps are taken. Key differences between an LLC treated as a partnership and an LLC treated as a sole proprietorship are that partnerships have more than one owner and file a separate tax return to report the partnership’s income. Sole proprietorships generally report their income on a Schedule C, which is a component of the federal individual income tax return (Form 1040).
Pedro: Got it. What else should business owners be aware of regarding the new tax reform?
Travis: Under the new tax law, bonus depreciation has been expanded to allow the taxpayers to claim a 100% first-year bonus depreciation deduction on property that’s new to the taxpayer and placed in service after September 27, 2017 and before December 31, 2022, whereas this percentage was 50% for 2017 prior to the new tax law. Also, entertainment expenses are generally no longer deductible, whereas in the past these types of expenses were generally 50% deductible. And make sure not to overlook any federal, state or local tax credits!
Josh: What else can you tell us about federal, state and local tax credit opportunities?
Travis: First, there are WOTC (Work Opportunity Tax Credits) that can be beneficial, particularly to business owners in the hospitality industry (like hotels and restaurants), but can apply to nearly any industry. WOTC is a federal tax credit available to employers that hire and retain individuals from target groups with significant barriers to employment. So, business owners might consider hiring from underutilized employment categories, such as veterans or ex-felons, to get a tax reduction. Keep in mind you need to be registered for this program in advance and file the appropriate forms shortly after hiring these targeted employees.
Also, many state and local governments offer credits and incentives to businesses to start up, expand or even remain within their borders. Depending on your jurisdiction, credits and incentives may be available to help businesses that are expanding their current operations, investing to add, retain, and train new and current employees or even purchasing large equipment. Having the right advisor on hand can go a long way to helping your business increase these opportunities for tax reductions.
Pedro: Great suggestions. Anything else that business owners should be mindful of? And is there anything that business owners can do moving into the home stretch of the year?
Travis: In terms of year-end tax planning for 2018, work with a tax advisor to understand your tax situation, taking into consideration the recent changes in the tax law. It’s no longer as simple as buying a new piece of equipment to decrease your taxable income; the added complexity of things like the QBI deduction and other provisions of the new tax law makes tax planning challenging yet important.
There are many nuances and industry-specific considerations under the new tax law. I would strongly encourage business owners to check out BKD’s Tax Reform Resource Center for additional information.
We’d love to hear from you. We are offering $100 to the reader whose question is selected next. Please submit your business questions to together@lead.bank.
