Post Title

As most of you are likely aware, the Tax Cuts and Jobs Act was signed by President Trump and became law in December of 2017. There has been no end to the debate as to whether or not the changes will benefit individual taxpayers, as tax situations can vary so greatly from one family unit to another. Opinions among business owners also seem to vary, though there has been a shroud of mystery for many as to how these changes affect their businesses.

The National Association for the Self-Employed (NASE) has said that 83% of small business owners do not fully understand the potential impact of these changes to their business. They also have shared that 90% of small business owners don’t believe they have been properly advised and prepared for these changes by the Government.

While the ultimate goal of lowering tax liabilities appears to have been accomplished, the overall tax system has not really been simplified to the extent it is easily understandable for most business owners. Hopefully this article can shed a little light on how your business may be affected and give you some confidence on what March 15th and April 15th of 2019 will mean to you.
Before diving into the changes, it probably makes a little sense to explain the different types of taxable entities and understand how your business is taxed.

Corporations – A popular misconception is that all corporations are gigantic businesses like Amazon, Google, Apple, or Wal-Mart. This simply is not true. We advise plenty of Oklahoma City area clients who own corporations doing well under $1 million in annual revenue. Corporations pay taxes on their net income (revenues minus deductible expenses) just like an individual would.
The corporate income tax rate was at a rate of 35% for roughly 35 years, since the Reagan-era tax cuts were put into place. The biggest change for Corporations under the new tax law is the rate itself, which was lowered from 35% to 21%. This amounts to massive tax savings for corporations. How this impacts the economy remains to be seen, but many corporations have already committed to repurpose those tax savings into various forms of business investment.

Pass-Through Income Entities – 95% of US businesses fall into this category, which means the business’s net income actually ‘passes through’ to the owner’s individual tax returns. Sole Proprietorships, Partnerships, and LLC’s all fall into this category. The entity itself will not have a tax liability, but the owners of these entity types will.

Included in the new tax is a potential 20% deduction of the Qualified Business Income (QBI). QBI will typically be the business’s net income. Unfortunately, this 20% deduction is neither absolute nor guaranteed, and its complexity is a hotly debated topic halfway into the 2018 tax year.
Because this 20% deduction provides opportunities for many businesses to ‘game the system,’ a series of relatively complex checks and balances have been put into place. These potential obstacles for taking the deduction can vastly change the game as the size of the deduction will vary depending on the nature of the business as well as the total income of the owners.

Yes, you read that correctly, certain business types will be taxed differently than others after applying the QBI Deduction. Some companies are designated as Professional Service Companies. Examples would be lawyers, doctors, accountants, professional athletes, business consultants, and financial advisors. Owners of these business will begin to see their QBI deduction phased out at a combined income of $315,000 for a married couple or $157,500 for single filers. The QBI deduction for these companies will be completely phased out at married income of $415,000, or single filer income of $207,500.

Owners of other businesses like plumbers, electricians, mechanics, roofing contractors, and homebuilders would not see their QBI deduction phased out. While this does not seem fair or follow any logic I can see, it is now the law of the land.

Specifically, the verbatim guidance provided on what is a professional service company at this point is as follows:
“Any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees or owners.”

Because this is all so fresh, there is little guidance provided and no case law precedents to refer to. Loss of the QBI deduction could amount to loss of potential tax savings of $15,000 - $30,000 or even more in some cases.

A self-employed plumbing contractor who is taxed as an S-Corporation and makes $400,000 will absolutely pay more in taxes than a self-employed dentist who makes the same. This could open the doors for getting deep in tax planning for the professional service company owners who expect to be or are already higher earners.

Confused yet? I am fairly certain this was by design. The more confusing the tax laws are, the more difficult they are to comply with. This makes the task of an IRS examiner much easier as the likelihood of errors being present is much higher.

If you are confused by how the new tax law may affect your business and your family’s bottom line, it is highly recommended you sit with your preferred tax professional as soon as possible.