Phil Castle, The Business Times
Tax season usually starts slowly, but Michael Brooks knows the pace of work will quicken as filing deadline nears.
Brooks also expects the work will become all the more challenging this season in dealing with what he says are the most comprehensive federal tax reforms enacted in decades, changes that affect nearly every business.
Among other things, the changes include a new 20 percent deduction on qualified business income. But the regulations are anything but simple, he says.
His advice? Consult with a tax advisor not only to correctly complete paperwork for the 2018 tax year, but also consider changes that could offer benefits in subsequent tax years.
“If you’re a business owner, it’s probably pretty important,” says Brooks, tax supervisor with Dalby, Wendland & Co., a Western Colorado accounting and advisory firm based in Grand Junction.
The Tax Cuts and Jobs Act of 2017 altered everything from tax rates and tax brackets to the forms used to file returns, Brooks says. “They changed a lot.”
The legislation cuts corporate tax rates from 35 percent to 21 percent. In lieu of lower tax rates for other types of business entities, the legislation provides a 20 percent deduction for qualified business income starting with the 2018 tax year and continuing through the 2025 tax year, he says.
The deduction is available to sole proprietorships and such so-called pass-through entities as partnerships and
S corporations — the owners of which are taxed directly on business income.
Certain exceptions apply, though, to what are termed specified service trades or businesses — including those in involved in accounting, consulting, financial services, health care, and law — in which the principal asset of a business are the skills or reputations of the owners or employees.
The 20 percent deduction applies to qualified business income from the sale of products and services minus losses, but excludes investment income, Brooks says.
A business owner who made $100,000 in income in 2018, for example, would receive a $20,000 deduction and pay taxes on $80,000.
Some limits come into play if taxable income falls between $315,000 and $415,000 for those who are married and file joint tax returns and $157,500 and $207,500 for others. Limits are phased in between those taxable income ranges. They are fully phased in above the $415,000 and $207,5000 limits.
Within the range, the 20 percent deduction can’t exceed the greater of 50 percent of W-2 wages for owners and employees or the sum of 25 percent of W-2 wages and 2.5 percent of the unadjusted basis in all qualified property. The deduction is intended for small businesses while also benefiting large businesses that create jobs and purchase equipment, he says.
Above the $415,000 and $207,500 limits, the deduction is the lesser of 20 percent of qualified business income, 50 percent of W-2 wages or 25 percent of W-2 wages plus 2.5 percent of the unadjusted basis in all qualified property.
The owners of specified service trades or businesses still can qualify for the deduction if their taxable income falls below $315,500 for those who are married and file joint returns and $157,500 for others. The deduction phases out above those limits and disappears at $415,000 for taxpayers who are married and file joint returns and $207,500 for others.
Rental real estate owners who work at least 250 hours a year in managing their properties qualify for the deduction, Brooks says. The deduction doesn’t apply, though, when real estate owners rent to tenants using triple-net leases requiring them to also pay insurance, maintenance, real estate taxes and utilities.
Given the changes and deduction, Brooks says business owners should first consider how their operations fit with the qualifications and then determine if any limitations for taxable income apply.
Since some final regulations and technical corrections still haven’t been issued, some business owners might want to file for an extension on their tax returns and wait to see what happens, he says.
The changes also afford opportunities to consider changes to maximize deductions in coming tax years, he says, by changing wages, increasing staffing, investing in buildings or equipment or combining companies.
There’s also the option to convert a business to a C corporation to take advantage of the lower flat corporate tax rate, although other tax consequences could result, he says.
While tax season starts slowly, Brooks expects the pace of work to not only quicken, but also present new challenges. “It’s not simple at all.”