We hope everyone had a wonderful Thanksgiving holiday. We certainly did! The Holiday season is now upon us. We hope you take the time, before year-end, to see if the Tax Cuts and Jobs Act of 2017 (“TCJA”) has left a Christmas gift for you. TCJA substantially changes tax law for your 2018 returns. It is the most sweeping modification since the Tax Reform Act of 1986. While TCJA was promoted as a simplification (“you can file your taxes on a postcard”), it is far from that. However, despite lots of changes, there may be some tax savings for you.
Last week, before the Thanksgiving fun started, I attended the two-day annual Clemson University Income Tax Course. Here is an 8-page summary of the major income tax changes as prepared and presented at the seminar by Burkett CPAs in West Columbia, SC. (Click here.)
Certainly, the newest and most complicated concept is the Qualified Business Income Deduction (“QBID”). We spent at least 8 hours on this topic and our presenters said we could have spent four days. The QBID is a 20% deduction available on “pass-through” income from partnerships, limited liability companies, S Corporations, trusts, estates and sole proprietorships. The concept of QBID was to provide a comparable tax cut to small businesses that “regular” corporations, including all the huge publicly- traded companies, were receiving in TCJA through a reduction in the corporate tax rate from 35% to 21%.
QBID is fairly simple and straightforward for married taxpayers whose joint taxable income prior to the QBID does not exceed $315,000 (50% of that amount, or $157,500 for other taxpayers). You simply calculate the Qualified Business Income (“QBI”) from your pass-through and multiply it by 20%. $200,000 in business income produces a $40,000 deduction. If your QBI exceeds your taxable income less net capital gains, you are limited to 20% of the smaller amount. The QBI includes businesses of all kinds, whether or not you are active in that trade or business.
When taxable income before the QBID for a married couple is greater than $415,000 ($207,500 for other taxpayers) the calculation becomes more complicated in two ways. First, income from a whole group of businesses known as Specified Service Trade or Business (“SSTB”) is excluded from qualification as QBI. The SSTB includes services such as doctors, lawyers, accountants, performing arts, financial services and wealth managers. None of these professionals will get any QBID from their core businesses if their joint taxable income exceeds $415,000. Ouch.
The other provision for higher incomes is that the business (which again can’t be an SSTB) has to pay wages equal to 40% of the QBI or the QBID is limited to 50% of the W-2s of the company. Wages are prorated to the partners, shareholders and beneficiaries of the pass-through. Companies, like real estate developers, who don’t have significant wages can instead use 2.5% of the cost basis, before depreciation, in qualified business property. The W-2 test is typically not a problem for most businesses, since the business wages only need to be 40% of the business income to get the full QBID.
For married taxpayers with taxable income before the QBID between $315,000 and $415,000 (50% of this for other taxpayers) there may be a reduction in QBID based on SSTB status and W-2 wages.
As you can see, the QBID can be very, very significant. Smaller companies, whose married owners have taxable income less than $315,000, don’t need to have any payroll, but they will need company payroll above that threshold. Married owners with taxable income may want to keep their salaries lower to maximize the amount considered as QBI. Wages and guaranteed payments paid to owners and partners are not part of QBI, so the larger they are, the smaller the QBI will be.
Most small businesses review year-end tax projections with their CPAs in November and December. Since the interplay of taxable income, wages and QBI is so important to maximizing the QBID, it is extremely important for all small businesses to review taxes under TCJA before year-end.
Other key provisions affecting business owners include the elimination of tax-free exchanges for cars and equipment, limitations on utilization of net operating losses, increased availability of cash basis accounting, and elimination of the domestic production activities deduction.
For our non-business owners, there are other new provisions in TCJA which include eliminating exemptions and miscellaneous itemized deductions, capping state and local taxes at $10,000, doubling the standard deductions, reducing tax rates, increasing the child tax credit, possible reducing of mortgage interest deductions, changing the taxation of alimony and no longer allowing Roth conversions to be recharacterized. These could have a big impact on your 2018 income taxes.
The Holidays are wonderful and typically very busy for all of us. TCJA ushered in significant changes to income taxes for all individuals and may be bringing you a 2018 Christmas gift. Make sure you and your CPA review your situation before year-end to make sure you understand how the TCJA impacts you and how you can structure your personal finances to take the greatest advantages of its changes. At DWM, we do not prepare tax returns. However, we do provide tax projections for our clients based on our experience and knowledge to help them identify key elements and potential strategies to reduce surprises and save taxes (aka Christmas presents). Time is running out in 2018. Don’t forget to do your year-end tax planning! And, of course, contact us if you have any questions.