While the GOP tax overhaul brings a new deduction to qualifying pass-through entities and tax cuts to corporations, it also brings a new layer of uncertainty to many small businesses.
Since the tax plan was passed, accountants say they’ve been fielding calls from business owners unclear on whether they qualify for the breaks and whether it pays to change their business structure.
“I’ve been getting calls 24 hours a day,” says Jeffrey Cohen, a tax partner at Grassi & Co., a Jericho-based CPA firm. “Companies are asking ‘What should we do?’ . . . there’s a lot of confusion.”
And the answer isn’t clear-cut.
Small businesses should carefully weigh their options before making any sudden changes, says Stephen Breitstone, head of the private wealth and taxation group at Meltzer, Lippe, Goldstein & Breitstone in Mineola.
“Everybody feels a lot of pressure to make a decision since the new tax law went into effect Jan. 1,” Breitstone says. Instead, “everybody should move at a very measured pace. I expect to engage in a conversation with virtually every client I have about how they should be structuring or restructuring their affairs going forward.”
Under the new tax plan, certain qualifying pass-through entities such as limited liability companies [LLCs], S-corporations and partnerships, could be eligible for a 20 percent deduction of pass-through income, says Breitstone. With a pass-through entity, profits are “passed through” directly to the owner and taxed at the individual tax rate, rather than the corporate rate, he says.
Separately under the tax plan, corporations or C-corps, which are taxed at the corporate level, will see their tax rate cut from 35 percent to 21 percent, he says. It may or may not pay for a pass-through to convert to a C-corp.
To be sure, the 20 percent pass-through deduction is definitely a relief for many businesses, considering these businesses could be taxed at a top rate of 37 percent in 2018, Cohen says.
But there are limits on this deduction, and those in certain service industries, including many lawyers and CPAs, will not benefit due to adjusted gross income limitations, he says. Among the limits, the deduction begins to phase out for certain service providers earning $315,000 for joint filers and $157,500 for individuals, says Cohen.
John Robertson, owner of the Sexy Salad Catering Co. and Build A Burger in Hauppauge, says he believes he will be eligible for the deduction for pass–throughs, but while he gains on the business front, he loses on a personal level.
“Personally this tax bill hurts me because it limits the deduction for state and local income taxes,” he says. “So where I lose from one, I win on the other.”
Starting this year, individuals face a $10,000 cap on their deduction for state and local taxes, including property taxes, where previously it was unlimited, says Barbara Weltman, a Vero Beach, Florida-based small business tax specialist and author of “J.K. Lasser’s Small Business Taxes 2018” (Wiley; $22.95).
Robertson says there are still many details to discuss with his accountant to see how he’ll fare come tax time next year.
Chris Lopinto, president of Patchogue-based ExpertFlyer.com, a subscription-based travel information site for frequent fliers and business travelers, already knows he’s on the losing side of the equation. His business is an LLC.
Due to the income thresholds, he won’t be eligible for the 20 percent deduction for pass-throughs as an individual filer. On top of that, the new tax plan places him in a higher federal tax bracket and he’s limited on the deductions he can now take for state and local taxes.
“Individuals in high-tax states like New York are losing out,” says Lopinto.
He says he won’t consider converting to a C-corp because of the double taxation burden.
A C-corp is taxed at the corporate level and then again on the dividends distributed to shareholders, says Weltman.
While the tax plan slashes the C-corp tax rate, owners shouldn’t necessarily jump from a pass-through structure such as an S-corp to become a C-corp without careful analysis, she says.
While there are advantages to being a C-Corp (for example, an owner can get tax-free health coverage), there are drawbacks (ie. double taxation), she says. Also if an S-corp election is revoked, it usually cannot be re-elected for five years, says Weltman.
At the same time, there are many limitations to the pass-through deduction, and it sunsets after 2025, she says.
“Accountants around America are trying to get their heads around this new law,” says Adam Looney, a senior fellow in economic studies at The Brookings Institution in Washington, DC. “It’s quite complicated, and there’s not one option that’s clearly the best one.”
He believes some businesses will choose to convert to a C-corp. Also, wage earners may try to become self-employed in order to take advantage of the 20 percent deduction for pass-throughs, he says.
Deborah Sweeney, chief executive of California-based MyCorporation.com, which provides online legal corporate filing services for entrepreneurs and businesses, says in the past few weeks she’s seen an 18 percent increase in people looking to form corporations and pass-through entities.
In part, the new year often brings more inquiries, but she believes the new tax plan has also contributed.
“It’s definitely opening up the discussion,” says Sweeney.
- Roughly 95% of businesses in the United States are considered pass-throughs — entities such as LLCs, S-corps and partnerships — where profits are “passed through” to their owners’ individual tax returns and taxed at the individual rate.
- Part of the reason for the popularity of pass-throughs is that before the new tax law, C-corps were taxed at 35%, plus C-corp shareholders also pay taxes on capital gains and dividends, putting the combined tax rate over 50%.
- Sole proprietorships — generally operated by a single taxpayer — are the most common type of pass-through business and represent about 43 percent of pass-throughs and 41 percent of all businesses.
Source: Adam Looney of The Brookings Institution