The passage of the Tax Cuts and Jobs Act in December 2017 ushered in significant changes to the U.S. tax code. From new tax deductions to accounting method changes to succession-planning opportunities, below are some strategies for business owners to consider with a new year underway. As with most tax provisions, there are no cookie-cutter applications for these concepts – it all depends on your business circumstances and objectives, so be sure to discuss the specific details with your…
Under tax reform, certain business owners can avoid tax on 20 percent of qualified business income. The Section 199A deduction, named after the new Internal Revenue Code section created by tax reform, may result in lower taxes for the owners of eligible pass-through entities. There are many factors at play when determining eligibility for and amount of this deduction, including income thresholds and phase-outs, employee wages, type of business activity and more, so be sure to discuss with your tax adviser.
Access to accounting methods
Tax reform opened the door to the use of different accounting methods for businesses. Starting in 2018, businesses with average annual gross receipts of up to $25 million are now able to switch from the accrual method of accounting to reporting on a cash basis. Eligible organizations may also be able to avoid certain accounting rules for inventories. Your tax adviser can help you assess the benefits of changing accounting methods and make sure to implement the change correctly.
Tax reform allows owners to garner more immediate savings from larger business deductions and expenditures. Qualified new (and for the first time, used) property purchased between Sept. 27, 2017 and Dec. 31, 2022 is now 100 percent deductible through bonus deprecation. Smaller businesses may want to consider taking advantage of the increased Section 179 limits to immediately expense the cost of property including software, equipment, furniture, fixtures, and non-residential property like HVAC, fire protection and alarm/security systems. Both of these strategies require strategic advance planning, so make sure to discuss all tax implications of asset purchases with your tax adviser.
Limits on interest expense
If your business has more than $25 million in revenue, your amount of deductible interest expense is capped under tax reform at the sum of 30 percent of adjusted taxable income, business interest income and floor-plan financing interest expense for years 2018 and forward. Tax reform defines interest expense as taxable interest paid or accrued on indebtedness allocable to a trade or business, so investments in tax-free municipal bonds do not increase a taxpayer’s interest expense deduction capacity. There are a number of applicability procedures, rules and complexities – like partnerships or S Corporations treatment or carryforward for disallowed interest – that require professional guidance to maximize benefits.
Succession planning opportunities
While tax reform retained the maximum federal estate tax rate of 40 percent, the exemption amount for married couples doubled to $22.4 million. Like other individual provisions of tax reform, this joint exemption will return to previous rates after 2025 barring future legislative action. Business owners should seize this window to consider whether an increase in gifting or making additional irrevocable generation-skipping transfer gifts can enhance current succession planning efforts.
The reduction of the corporate tax rate to 21 percent garnered many tax reform headlines and prompted many pass-through owners to ask if they should switch to a corporate structure. While the answer depends on individual business circumstances, in general the answer is probably not. As described above, the new Section 199A provides a fairer playing field for pass-through business owners. Other factors like state tax implications, especially for Pennsylvania businesses, must be considered. The Pennsylvania tax rate for C Corporations is 9.99 percent, while the individual tax rate applicable for pass-through entity owners is 3.07 percent.
Jonathan M. Clark is a CPA and partner in the Tax Services Group of RKL LLP in Wyomissing. He provides strategic tax planning and compliance solutions to privately held businesses and their owners. He can be reached at email@example.com