The good news is the Tax Cuts and Jobs Act creates a brand-new tax deduction for owners of pass-through entities, including partners in Partnerships, shareholders in S Corporations, members of Limited Liability Companies (LLCs) and Sole Proprietors. The bad news is the new tax break is very complex!
Tax Reform may also have made some small business strategies outdated with regard to finances and taxes. Depending on factors like revenue, entity type, and whether there are additional employees, it may make sense for a small business owner to speak with their tax professional and trusted advisor at Fuoco Group about restructuring their entity in order to maximize tax savings.
Advance tax planning can make a difference in the effective tax rate and help small business owners reap the benefits of new tax policies. Here’s just a few valuable tax planning tips to consider:
Entity Choice
If you chose to operate as an LLC or S-Corp it was probably because prior tax rates on pass through income was taxed at a lower rate and double taxation with a C-Corp was avoidable. Owners of pass-through entities are effectively taxed on earnings at individual tax rates, similar to the way corporate owners are taxed on wages. Under the TCJA, tax rates for individuals are generally lowered over seven brackets, featuring a top tax rate of 37%. But since corporate tax rates are now 21% not 35%, it may be time to review your decision. It might also make sense to reconsider if a pass-through entity will best serve both short and long-term business goals. Perhaps if in the future there is an opportunity to raise capital from foreign investors, being a C-Corp might be a better fit.
Establish Qualified Business Income
The new law provides a deduction of up to 20% for pass-through entities on “qualified business income.” QBI is generally defined as net income from your business without counting compensation, and excluding any investment income from the pass-through entity. But to claim the full 20% deduction you must meet the test for “specified service businesses” and a “wage and capital” limit. This is the IRS so naturally there are thresholds and exceptions to the exceptions to make things even more confusing. In a nutshell, taxpayers who have income below the lower income threshold of $157,500 for individuals and $315,000 for married taxpayers filing jointly have no worries at all. They get the full deduction. But the deduction can’t exceed your taxable income for the year (reduced by net capital gain). The upper threshold of $207,500 for single filers and $415,000 for joint filers may cap or phase out the pass through deduction. Those in certain service professions traditionally high-paid, such as physicians and attorneys, may not qualify for any deduction. If the net amount of your QBI is a loss, you can carry it forward to the next tax year.
Examine Benefit of Independent Contractor Status
Don’t be tempted to reclassify wages as QBI eligible for the deduction by establishing yourself as an Independent Contractor. The IRS has a huge problem with this and has made it a point of contention recently. If you are already treated as an IC, stay below the income thresholds that will allow a deduction. If your work is characterized as consulting, it is likely to be subject to the specified service business test which includes all taxable income – including capital gains from securities sales. It will be difficult for certain high-income taxpayers to qualify, period.
Expense Substantiation
If you want to maximize the new pass-through deduction, substantiating expenses is essential. That means writing down who you dined with for business meal expenses, as well as keeping legible records and receipts, not just relying bank and credit card statements for proof of business expenses. If there is doubt or a tax authority has to guess, it’s more than likely to exclude deductions and count your claimed expenses as income.
Expect To Get Organized
If you are a small business operating as a pass-through LLC or S-Corp, you must get serious about keeping business and personal expenses separate. Learn to keep a spreadsheet with detailed notes or invest in bookkeeping software, but either way you need to reconcile expenses. Most accounting or bookkeeping software now has a mobile app to make things even easier! If you are not willing to do the bookkeeping work it’s time to hire a professional to do it. The new tax era of tax change demands it.
Contact Us: Our professionals can show you how tax reform may impact your taxes and develop tax planning strategies to help maximize your tax savings. You have questions – Fuoco Group has answers. Stay tuned to fuoco.com for updates as soon as guidance is handed down.
