The 2018 Tax Reform Bill signed into Congress in December 2017 is the biggest tax law change in 40 years. Now that your 2017 books are closed and your 2017 taxes are ready to be filed, careful consideration needs to be made to prepare your business for your 2018 tax filing.
Companies that have elected to file taxes as S Corporations will likely be the most affected by the 2018 Tax Reform Bill. Those companies may consider filing as a C Corporation, the default category of companies that have not elected to file as S Corporations, but have to make the switch before March 15, 2018 in order for the C Corporation filing status to be effective for 2018 tax returns.
In the past, C Corporations have been taxed at income tax rates ranging from 15% to 35%. Under the 2018 Tax Reform Bill, C Corporations will now be taxed at 21% across the board.
Currently, there is no business deduction when filing taxes as an S Corporation; any profit income is “pass-through income” that goes to the owner of the company to file on his personal income tax return. Under the new law, an owner of an S Corporation will be given a 20% Qualified Business Income Deduction. This will effectively reduce personal income taxes.
Simple Real Life Example:
A manufacturing company filing as an S Corp has a net profit of $234,000 in 2018. The owner files W-2 income of $108,000.00 and Qualified Business Income of $234,000 on his 2018 Income Tax Return. He is filing with a Married Filing Jointly status and will be able to take a 20% Qualified Business Income Deduction of $46,800 making his total taxable income $295,200. After $32,000 in itemized deductions, his total tax liability will be $97,384. (His company remained flat from 2017 to 2018. His tax liability in 2017 was $102,145.)
However, there are exceptions for the type of businesses that can claim the S Corporation Qualified Business Tax Deduction. Entities that are considered “service businesses” will not be eligible to take the 20% deduction for pass-through income. The businesses specifically included as “services businesses” are: Health, Law, Accounting, Actuarial Sciences, Performing Arts, Consulting, Athletics, Financial Services, and any other trade or business where the principal asset of the business is the reputation or skill of 1 or more of its employees. Architects and Engineers are not considered “service businesses”.
The 20% pass-through deduction will be implemented in a “phase-out” for those currently in service industries. There will be income thresholds with the upper limit for Individuals is $157,500 and Married Filing Jointly is $315,000. Once an owner reaches $207,500 for an Individual or $415,000 for Married Filing Jointly, they are no longer eligible for the 20% pass-through deduction.
There are many more complications, exceptions, and questions yet to be answered in the 2018 Tax Reform Bill and if you are a small business owner, I advise that you meet with your CPA in the first quarter of 2018 before March 15th to ensure that you will not be taken by surprise when it’s time to close the books out at the end of December. After careful evaluation of your financial status, your CPA may or may not recommend that you change how your organization is classified with the IRS.
Craig Auer, CPA, Principal at AuerCPA Co., is a Tax Reform Specialist with over 20 years’ experience helping small business owners focus on their day to day business while he focuses on the financial health of their company. AuerCPA Co. is a boutique accounting agency that has a team of professionals who are ready and dedicated to helping small business owners, executives, and independent professionals run their businesses with ease by taking on the financial supervision of their organizations. 419 Canyon Ave, Suite 224, Fort Collins, CO, 80521; (970) 797-3227 http://www.auercpafirm.com/