There’s almost a month before Tax Day 2018, but many business owners are already looking ahead to next year’s deadline, when certain implications of the federal tax overhaul passed in December come into play.
One of the most-talked about provisions of the law, according to tax specialists and wealth managers, is the qualified business income deduction, which can give small business owners up to a 20 percent deduction on taxable income if certain guidelines are met.
But figuring out who qualifies for the deduction is a fraught process, according to Raymond Edwards, a principal at West Los Angeles-based wealth management firm Aspiriant.
“Every provision in the law has an exception and all the exceptions have exclusions,” he said.
As currently construed, the law requires a recipient of the tax break to receive income from a qualified business, which in most cases excludes professional services such as law, consulting and accounting firms. The income also must come from what are often referred to as “pass-through” entities, which excludes C-corporations but includes S-corporations, partnerships, sole proprietorships and LLCs where profits are passed through to individual business owners as taxable income.
There is a cap on the amount of taxable income eligible for the 20 percent deduction – $315,000 for a married couple filing jointly and $157,500 for an individual. After those caps are hit, the deduction is reduced incrementally until it is fully phased out at $415,000 for married couples and $207,500 for individuals.
Tax professionals see these as basic guidelines for who can take advantage of the provision, with numerous workarounds, minutiae and ambiguities that can impact who is eligible.
The qualified business interest deduction is an entirely new addition to federal tax code, which means how it is ultimately interpreted by the Internal Revenue Service is also still very much up in the air, according to James Slouber, a Century City-based managing director in Cleveland-based CBIZ Inc.’s tax practice.
“There are a huge number of inconsistencies within the bill and we have no idea how they will be reconciled,” he said. “When will we get guidance from the IRS? Are there going to be technical corrections? We don’t know right now.”
Business structures
The big question facing small businesses owners is whether to organize as a pass-through entity like an S-corp., which would potentially give them access to the 20 percent qualified business interest deduction, or structure their holdings as a C-corp. Because corporate tax rates applied to C-corporations were also slashed as part of the tax overhaul, dropping from 35 percent to 21 percent, it can be difficult to figure out the answer without a full assessment of a business.
The added uncertainty of how the new qualified business interest deduction will be applied leaves both advisors and business owners in a difficult spot because the law went into effect Jan. 1. In order to maximize potential qualified business interest deductions based on revenue this year, business owners who do meet the criteria should already be thinking about – and possibly implementing – changes to their business structure.
“If you’re going to make changes, the sooner you do it the better,” Slouber said. “The problem is, there are a lot of unanswered questions.”
Even after the structure of the business is set up, there are host of other considerations that must be mulled over, according to Edwards.
“Say I’m a business owner and in the past I’ve paid myself a salary,” he said. “Do I still want to do that? I might not. Instead it might be better to, say, take a distribution from the company.”
The number of exceptions and exclusions in the new law make it difficult to draw any sort of generalizations and that has many individual clients asking their advisors about what they should do.
“For my clients, it’s difficult to assess the full implications of this new deduction,” Edwards said. “It’s a brand new law. There was nothing like it before.”
