When the Tax Cuts and Jobs Act (TCJA) was enacted, upending tax brackets and delivering other significant changes, one of David Ritter’s clients considered restructuring his business from a partnership to a Subchapter S corporation. “But because of the number of W-2 employees in the business, other provisions of the TCJA meant that it was better, from a tax viewpoint, to retain the partnership structure,” said Ritter, the Roseland-based chair of the tax practice at Brach Eichler LLC, a multidisciplinary law firm. “Choices like this depend on specific facts and circumstances.”
The TCJA offers some opportunities, including the ability for eligible “pass-through” entities — where profits or losses flow through to the owner at his or her individual rate — to exclude up to 20 percent of qualified business income (QBI) for tax purposes. But business owners and their advisers have to engage in careful analysis, according to tax and other professionals.
Certain professional services — including accountants, lawyers and doctors — may be subject to income limitations that could restrict their ability to take the qualified business income deduction. There could be an out, however.
“Some professional service providers may have multiple lines of business, and some of those may be able to be carved out as a separate business so they’re not subject to those QBI limitations,” noted Ritter. An ophthalmologist whose income would otherwise make him or her ineligible for the qualified business income deduction, for example, “may also have a retail shop that does not fall under the limitations of the ‘professional services’ category. So he or she may be able to move that business to a separate entity and take advantage of the QBI deduction. But it’s important to note that such an action may be subject to or prohibited by other restrictions, including IRS or professional medical regulations. So there are no easy answers.”
There are “many moving parts” to the new tax laws, according to Robert McGuinness, a Parsippany-based director in the Commercial Business Group of the Marks Paneth LLP accounting firm. “Because of new depreciation schedules and other changes, business owners need to consider their projected cash flow, borrowings, and how much equipment they expect to buy, before they enter into any significant transactions,” he said. More small businesses may also have more choices about issues like using the cash method or the accrual method of accounting, and whether to expense inventory or capitalize it, he added.
Individuals also need to analyze their strategies under the new regulations. The new law, for example, generally doubles the lifetime amount that can be excluded from estate and gift taxes to $11.18 million, at least from 2018 through 2025. “So taxpayers may want to consider setting up trusts, or making a gift of stocks,” McGuinness said. “But you should think carefully about it before doing anything.”
Individuals, particularly those in high-tax states like New Jersey, may also need to review their situation. “One of our clients, a retired individual, was concerned about the new limits on taking a SALT [state and local tax] deduction,” noted McGuinness. “But this person has a lot of investments, and was subject to the Alternative Minimum Tax, which generally disallowed a deduction for state and local income and property taxes anyway. Because of other changes under the new act, it looks like he’ll actually save about $9,000 a year.”
Some of the new federal tax depreciation rules, like a provision that can allow 100 percent bonus depreciation, or expensing, on certain assets, “may be a very favorable federal tax benefit for taxpayers that need to spend money on capital improvements to expand and grow their businesses,” according to Warren Abkowitz, a Short Hills-based tax partner at KPMG LLP. “For state tax purposes, however, New Jersey and many states have not adopted this provision to the full extent of the federal law,” he said.
Other potentially significant provisions need to be considered, “as they may be detrimental to some taxpayers,” he added. Among other issues, there’s a potential limitation on the amount of interest expense a business can deduct. In general, according to Abkowitz, the amount of business interest deduction for a taxable year “cannot exceed the sum of the taxpayer’s business interest income for the taxable year, 30 percent of the taxpayer’s taxable income for the taxable year with certain adjustments, plus the taxpayer’s floor plan financing [a kind of revolving line of credit] interest for the taxable year.” There are certain gross receipts and other exemptions to this provision, he said.
“Another revenue-raising provision that was passed limits the amount of trade or business losses a taxpayer may deduct,” said Abkowitz. “In the past, a taxpayer could deduct the full amount of a business loss against all other sources of income provided he or she had a basis — including at-risk basis — and materially participated in the activity. Under the new law, however, Section 461(l) generally limits the aggregate deductions attributable to trades or businesses of individuals, trusts and estates to the aggregate gross income or gain attributable to trades or businesses of the taxpayer plus a threshold amount.”
The threshold amount for 2018 is $250,000, or twice that amount in the case of a joint return, and any business deductions in excess of the amount allowed under Section 461(l) are considered to be “an ‘excess business loss’ that will be treated as a net operating loss in a subsequent tax year,” he noted. These and other changes “are very complex and as of today we do not have all the regulations issued and finalized, so it is as important as ever to consult with your tax adviser to work through these changes.”