2017 Tax Year is Almost Behind Us. How Will the New Tax Laws Affect You and Your Business in 2018?

2017 Tax Year is Almost Behind Us. How Will the New Tax Laws Affect You and Your Business in 2018? by Nadine Riley{8:24 minutes to read}  The chatter seems to have decreased regarding the new tax laws, but the uncertainty still seems rather high. The Tax Cuts and Job Act (H.R.1), which is now enacted, affects each of us and our businesses. The intent of the law is explicit in its title, however, in practicality some areas are still too complex to see how they tabulate on paper. For the most part, the effective date for enactment of the law is January 1, 2018, but some parts of the law (such as depreciation) do affect items purchased in 2017.

In my opinion, the three biggest changes are:

  1. 20% deduction for pass-through entities (such as LLC, partnership, S-Corp, sole proprietor);
  2. 21% flat Corporation (C-Corp) tax rate, decreased from 35%; and
  3. Deprecation increased and broadened for some asset classes.

Let’s take a look at five common general expenses that are changing:

  1. Meal and Entertainment Expenses (M&E): Prior to 2018 you were allowed a 50% deduction for M&E. Under H.R.1 entertainment is no longer deductible, however, meals will still be deductible at 50%.
  2. Depreciation increases for multiple business asset classes (including business vehicles). The bonus depreciation now allows a 100% depreciation expense in the first year for qualified assets placed in service after 9/27/2017 and before 12/31/2026. There are other depreciation methods that changed such as Section 179, which now allows up to $1M in annual deductions.
  3. Commuter Fringe Benefit to employees. This includes the $255 per month payroll deduction benefit for items such as transit, parking, etc.  
  4. Tax credit for family & medical leave (FMLA): H.R.1 now allows eligible employers to claim a new family leave credit (IRC § 45S). Employers can claim a tax credit between 12.5% – 25% of wages the employer pays to an employee who qualifies for and uses FMLA. Discuss this with your payroll provider as the credit is short-lived;
  5. Legal costs paid to resolve some types of lawsuits, i.e. sexual harassment, are not deductible. No deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement.

Let’s take a closer look at a few changes in some of the various tax entities.

C- Corporation:

  • Rate reduction from 35% to 21% is relatively straight-forward.
  • Cash vs accrual accounting method. Small businesses with revenues not exceeding $25M can now choose the method of accounting preferred. Prior to the new rule, the accrual method was required for companies carrying inventory and certain entities with gross revenues over $5M.
  • Net Interest Expense is limited if your gross revenue exceeds $25M.

Pass-Through Entities (S-Corp, Partnership, LLC, Sole proprietors):

This is where the restlessness is among most business owners.

Generally there is no federal tax for these tax entities. The business income for these entities passes through from the business to individual owners. The individual is then taxed at personal income rates on Form 1040 (to see these rates, Click Here).

H.R.1 added IRC 199A to the tax code, which is a tax deduction for business owners of “pass-through” entities. H.R.1 essentially provides a 20% deduction from your taxable income (coming from the business) to these owners which includes:

  • Partners of partnerships (K-1 box 1): The deduction is not allowed on any guaranteed payments;
  • S corporation shareholders (K-1 box 1): The deduction is not allowed on an S-Corp owner salary;
  • Sole proprietorships (Sch. C, Sch. E and Sch. F filers) who are individuals, estates, or trusts. The Schedule E activity must be a trade or business (including rentals).

While there is a 20% deduction from your personal taxable income, you may be subject to a reduced deductible amount if your personal taxable income exceeds $315,000 married/ $157,500 single (or no deduction). If your taxable income is $415,000 married/$207,500 single, you basically lose the deduction. The law dictates certain tests that should be performed when income is greater than $315,000 married/$157,500 single, BUT less than $415,000 married/$207,500 single.

Take Away and Navigating the Gray:

For M&E the question now gets raised, are we entertaining, promoting or advertising? Let’s rethink how we entertain our clients and prospects:

  • Independent contractors operating DBA or just operating under your name, considering forming an actual company under a legal entity (such as a LLC, Inc. or Corp, or request S-Corp status), let us help you with the setting up of a legal entity;
  • Salary for S-Corp owners – IRS still requires S-Corp owners to take a reasonable salary from the company. Though this salary is paid from the business income it cannot be a factor used to get the 20% deduction. Re-consider your “reasonable salary” amount,  if it is too high it may limit your deductible amount, under IRC 199A;
  • Home Office deduction is treated differently among the entities:
    • Under these new rules, the deduction for a home office becomes of primary importance for Schedule C, E and F filers because of the ability to allocate property taxes (for homeowners) from potentially non-deductible items on Schedule A to partially deductible on the appropriate business schedule;
    • S-Corp owners: Accountable expense plans should be used by employers to reimburse employees for allowable expenses including property tax for work from home situations. This is required for S-Corp owners if you take a home office deduction.
    • Partners and multi-members LLCs: Consider addressing this thru UPE (allowable unreimbursed partnership expenses), check eligibility in your p/ship agreement.

Here are 3 income tax planning tips pass-through entity business owners may want to consider:

  1. Retirement Savings – contribute to savings vehicles such as retirement;
  2. Increase your qualified business deductions – use a proper accounting system to record all your expenses, separate business and personal;
  3. Consider a home office if you have not yet done so; see above for each entity type.

This article is not meant to inform you of the most tax advantageous entity selection. You may want to consider a comprehensive tax planning analysis, since each individual and business entity is unique.

Nonetheless, if you are in the phase-out range, here is the advice echoed among some accountants: Consider a corporation (C-Corp), but keep in mind that C-Corp is taxed twice:

  • 21% at the company level; and
  • Possibly at an 18.88% – 23.88% rate on the dividend paid to you from the corporation (i.e. capital gain tax treatment).

Thank you for reading and I trust that you will find something usable from this article.

Nadine Riley, CPA
Founder, Masterpiece Accounting Group
Phone: (212) 966-9301
Email: info@mpagroupllc.com