The recently passed, voluminous Tax Cuts and Jobs Act contains several big changes, many of which are expected to benefit businesses, Spokane tax advisers say.
Anson Avery, accountant and owner of Anson Avery CPA PLLC, says he’s already put in over 65 hours of work studying all 588 pages of the new law, and he hopes to educate other financial advisers on his findings through a series of classes and lectures in the coming months.
“There were 180 changes proposed, and 119 of those were finalized and 61 were rejected,” he says. “In analyzing those changes, I’ve found that the majority are designed to stimulate the economy.”
Avery maintains all of the changes are encouraging for businesses. He says the top five changes most should be concerned with now include the corporate tax rate reduction, elimination of the corporate alternative minimum tax, new limits on business losses and net operating losses, the increased asset expensing option, and the 20 percent deduction on qualified business income for pass-through entities, such as sole proprietorships, partnerships, and limited liability corporations, among others.
“Most of these won’t go into effect until 2018 (tax year), but it’s important for businesses to start planning now,” he says. “Some may be pleasantly surprised by their returns, but it’s hard to know for sure until the books are balanced and changes are analyzed.”
Kelli Franco, an accountant and partner with the Spokane office of Seattle-based Moss Adams LLP, says the new law has some momentous changes.
“Tax reform is a really big deal,” she says. “We haven’t seen anything this sweeping since the 1986 changes.”
Franco and her colleague, Jason Munn, say most of the questions their businesses clients are asking about tax reform focus on Avery’s top two items—the corporate rate reduction and the deduction for pass-through entities.
“We’ve found that for businesses it’s particularly important to understand the type of entity you’re running, the deductions you’ll be losing, and the rates you’ll be paying under the new law,” says Franco.
The new law reduces the corporate tax rate to 21 percent from 35 percent, eliminates the alternative minimum tax for corporations, and creates a 20 percent business income deduction for some pass-through entities.
While corporations distribute their profits through dividends to stockholders, the income generated by pass-through entities is “passed” directly to business owners, who then pay the individual income tax rate on those profits.
Under the new law, the corporate rate was reduced to 21 percent, while the top individual income tax rate, which some pass-through business owners pay, is 37 percent. To address that disparity, lawmakers included tax relief for pass-through owners, allowing them to deduct 20 percent of their qualified business income.
However, Franco says determining which businesses qualify for the deduction—and how much they’ll be able to deduct—is a complex process.
She says the deduction is limited for those with taxable income in excess of $315,000 for married couples filing jointly ($157,000 for singles), and the deduction is limited to the greater of either 50 percent of W2 wages, or the sum of 25 percent of W2 wages plus 2.5 percent of the unadjusted basis of all qualified property.
Additionally, she says the deduction doesn’t apply to specified service trades or businesses, including law, health, consulting, and financial services.
“The deduction formula can be difficult to explain,” says Franco. “I’d advise business owners with questions to go over it carefully with their CPA or financial adviser.”
As part of that process, she says business owners should carefully evaluate their current business structure and consider whether it might make sense to change their entity status going forward.
“Ultimately, the best choice for your company will vary depending on several factors, including taxable income, the amount of W2 wages you pay, owner and individual rates, succession plans, and the state you operate in,” she says. “Overall, I think businesses no matter how they’re structured should see a nice tax break for 2018.”
Munn says the new tax laws’ most significant and permanent change for businesses is the reduced corporate tax rate.
“The corporate rate reduction aims to redistribute wealth through things like higher wages and bonuses,” he says. “We’re seeing some of that already, but the hope is that over time companies will continue investing and hiring.”
Although the corporate rate has been reduced, Munn says it’s important for business owners to understand that the new tax law also eliminates or changes the rules for certain other business deductions.
“Rates are going down for (subchapter C corporations), but businesses also need to be aware that certain deductions have been repealed or modified, which might result in a higher taxable income figure,” he says.
Profits are taxed at the individual level for C corporations.
Munn says most of the eliminated deductions, including those for business-related meals and entertainment, and those relating to certain employee fringe benefits, are relatively small changes.
“Those eliminations will still chip away at some folks’ tax savings,” he says. “But the big one to be aware of is the elimination of the manufacturer’s deduction.”
Also known as the domestic production activities deduction, the manufacturer’s deduction is a tax break for businesses that perform domestic manufacturing and certain other production activities.
“It was a large deduction that many manufacturers have previously counted on, so it’s pretty significant that it’s now been eliminated,” he says.
Aside from changes in deductions, Munn also says businesses should be aware of two previously mentioned items; the new rules pertaining to net operating losses and net interest expenses, and immediate expensing of assets.
A net operating loss is a loss taken in a period during which a company’s allowable tax deductions are greater than its taxable income. When more expenses than revenues are incurred during the period, the net operating loss for the company can generally be used to recover past tax payments.
Previously, Munn says, businesses had been allowed to carry net operating losses back two years, or forward 20 years. The new law repealed the two-year carryback option, allowing for net operating losses to be carried forward indefinitely, but limiting the deduction to 80 percent of taxable income.
“In the last economic downturn, this allowed companies the option of recovering tax dollars from previously profitable years in order to help them through lean times,” he says. “Eliminating that means there’s one less source of potential funds available for companies who are struggling.”
Munn says rules for net interest expenses, or costs incurred by an entity for borrowed funds, also have changed, although those changes may apply more to larger companies.
“The new law can temporarily disallow interest deductions for net interest expense in excess of 30 percent of taxable income without any deduction for depreciation, amortization, or depletion,” he says. “Smaller taxpayers won’t be subject to this change, but it could present a challenge for larger companies.”
The last change that Munn says companies should be aware of is the rule that allows for 100 percent immediate expensing of certain business expenses, including machinery, equipment, and qualified improvement property acquired and placed in service after Sep. 27, 2017.
“This change allows businesses that are buying assets to write off those costs more quickly, encouraging further investment and growth,” he says. “In the past, it could take companies years to recover those costs.”
Andrew McDirmid and Adam Sweet are accountants with the Spokane office of financial advisory firm, Eide Bailly LLP.
Similarly to other area financial firms, McDirmid and Sweet say most questions they receive from business clients on tax reform are about the reduced corporate rate and the deduction for pass-through entities.
“We get a lot of questions about the deductions for pass-through entities, especially the qualified business income aspect,” says Sweet. “Many clients also ask about the lower rate for corporations, and whether it might make sense to switch their business entity to become a corporation.”
Previously, Sweet says, the large difference between the corporate tax rate and the rate for pass-through entities encouraged more businesses to pursue pass-through entity structures instead.
“Now that the new law has reduced the corporate tax rate, many businesses are reconsidering a corporate structure,” he says.
Regarding the remaining top five changes, McDirmid says businesses should check with their financial adviser on the extent to which changes in net operating loss and net interest rules apply to their operations.
“The net interest rules in particular will apply more to larger or highly leveraged companies, so just be mindful of how leveraged you are,” he says.
McDirmid says the change that will likely be the biggest help to businesses, particularly those in the farming and agriculture industries, is the immediate expensing option.
“The immediate expensing option will be big for construction and farming industries, as they work with a lot of heavy equipment,” he says.
Overall, Sweet and McDirmid say they anticipate the changes will reduce tax burdens for many local businesses.
“There are still a lot of questions,” says Sweet. “Passing this law is the first step in the process, but it’ll take some time for the IRS and Department of the Treasury to work out additional guidelines associated with each of the changes.”
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