Capital One Spark Business released its latest Small Business Growth Index today and among its many findings, one in particular stood out. It seems that of the 500 business owners surveyed, only 36 percent believe that the 2017 tax reform bill will lower their taxes.
"Believe?" That's not good enough, is it? You don't want to "believe." You want to know. It's not difficult to know either. It's just math. So get out your pencils and call up your accountant. Then, focus your attention on your company's structure.
Regarding structure, most companies fall into three categories.
There are the very small businesses that report their income and expenses as sole proprietors on Schedule C of their personal tax returns. Everything gets taxed at their individual rates and, for the most part, those rates have fallen by a lot. For example, a married couple filing jointly and making between $75,000 and $250,000 a year will see their tax rates fall anywhere from 12 to 27 percent from 2018 through 2025 when the rates reductions expire. The standard deduction almost doubled as well to $24,000 for those same taxpayers.
Another structure is a corporation or C-Corp. There are the entities that file form 1120. Those businesses--mostly larger with more shareholders--will see their 2018 tax rates reduced from 35 percent to 21 percent.
The biggest issue is with the third type of structure, the "pass-throughs"--those of us who are S-corporations, limited liability companies or partnerships. The greatest amount of small companies fall into this category.
For pass-throughs, the rules get murkier. These companies would be allowed to deduct 20 percent of their income before the rest "passes through" to their individual return where it would then be potentially taxed at the lower rates mentioned above. But not everyone can benefit. Those making more than $315,000 per year (jointly) will see the deduction restricted. The break is also limited to 50 percent of wages paid or a combination of wages and assets. Also, certain service companies - lawyers, doctors and (darn it) accountants would also see the deduction phased out or restricted. Oh, and the whole thing expires in 2025 like the individual rates deduction.
Which brings me back to the Capital One report.
If the respondents are like the majority of my clients, I truly think that most of the 36 percent of those who "believe" that tax reform will lower their taxes--as well as the 64 percent who believe otherwise--actually don't really know. That's just not good enough.
Figuring Out How Tax Reform Will Affect Your Business
The good news is that you can truly find out whether the tax reform bill will benefit your business and at the same time figure out the best strategy for maximizing those benefits. I warn you, it's going to involve some math. But let your accountant handle that.
The exercise takes three steps:
Assuming your business is relatively consistent year to year, ask your accountant to run a pro-forma (estimated) income statement for your business in 2018 using your finalized 2017 numbers. From there determine how much tax you would owe under the new legislation and in your current corporate structure.
Next, have your accountant do the same exercise again...under a different corporate structure. If you're currently an S-Corp, do it as a C-Corp. Or if you're an S-Corp, see if you can break out "service" revenues from products with the idea of maybe putting services under a new entity with lower tax rates.
Play with these scenarios, but be careful. Breaking out "service" income to a separate corporation may or may not be kosher with the IRS--it's too early to tell. Your options may also be limited depending on what state you live in.
Once you've done that, just compare the numbers. Will tax reform benefit you under your current structure? Will changing your structure be a better tax strategy? Will breaking out profits and allocating some to a C-Corp and some to a pass-through make the most sense? Do this now, because depending on what you decide, you're going to need some time (and a large bottle of Jack Daniels) to go through the process.
I know, it seems like a pain and taxes suck. But really, don't all good things take hard work? Haven't we learned that to get what we want it's never easy? Isn't your tax bill probably the largest expense you personally pay every year?
Given the enormous changes that just happened, how can this exercise not be worth the effort?
Note: Capital One Bank is a client of my company, The Marks Group PC. I have received no compensation for writing this article.