5 things SMBs need to know about the new tax plan
President Donald Trump signed into law the most extensive rewrite to the U.S. tax code in 30 years on Dec. 22, 2017. It affects everything from tax rates to how families pass on wealth to their heirs. But for many small and midsize firms (SMBs), the pertinent question is how the legislation will impact business in the next few years.
To get answers, I turned to Aprio — a premier CPA-led business advisory firm with offices in Atlanta, New York, Sarasota and Birmingham. Special thanks to Mitchell Kopelman, Partner-in-Charge of Business Tax, Technology and Biosciences, as well as Chris Davis, Partner-in-Charge of Private Client Services. They laid out five major issues that SMBs must stay on top of under the new tax landscape:
- Choose your company structure carefully.
- Smaller firms have different considerations than larger firms.
- Tax savings are an opportunity to grow your business.
- Take advantage of estate tax exemptions.
- Beware of unintended consequences of the legislation.
Let’s explore each issue to see how it might affect your strategic decision-making in 2018 and beyond.
1. Choose your company structure carefully.
“Every small to midsize business should evaluate whether they should remain as an LLC, or an S-Corp or a C-Corp,” Mitchell says, pointing out that incentives in the tax plan are prompting many owners to debate restructuring their companies as C-Corporations. “Even the smallest of businesses should review. There are very detailed computations to make.”
The crucial factor is whether the business has a need to retain working capital or whether it needs to distribute earnings to its owners. A related factor is that an entity should appeal to a future buyer, for example by allowing the acquirer to receive a step-up in basis when they purchase the firm. That’s easily done with an S-Corp but not so when buying the stock of a C-Corp.
Furthermore, these are long-term decisions. Firms cannot repeatedly change their structure every couple years without introducing costly complications. Yet quite a few of the new tax provisions have expiration dates, so the law will either have to be extended or the tax code will have to be rewritten down the line. In addition, several tax changes in the new plan take effect years from now.
This means firms will have to choose a course and stick to it, without having a complete picture about how the tax code will affect them five or 10 years down the line.
2. Smaller firms have different considerations than larger firms.
New tax-rate and cash-basis rules influence smaller firms differently than larger firms. The newly lowered corporate tax rate of 21% and the 20% income deduction for flow-throughs must be weighed alongside the newly raised $25-million annual revenue cap for corporations and LLC’s using the cash-basis method of accounting.
Smaller firms have an easier time operating as flow-through or “pass-through” entities to avoid double taxation than large firms, which more commonly have a large number of shareholders. Plus, smaller firms tend to be more closely held — which facilitates taking out earnings each year to pay owners.
On the other hand, starting in the year 2022 the tax plan will prompt larger firms to bring overseas R&D facilities back to the United States for quicker write-offs, thanks to rules regarding a five-year amortization domestically as opposed to 15 years abroad.
3. Tax savings are an opportunity to grow your business.
The December 2017 Wall Street Journal/Vistage survey asked SMB CEOs and owners how they would use any tax savings as a result of the new bill:
38% of respondents said they would increase investment
24% said they would take more profits
14% said they would expand into new areas,
8% said they would boost wages, and
15% described various other preferred activities.
“The vast majority of owners should invest in their business, expand it, grow for the future,” Mitchell insists. “That’s what we would hope is the case with our clients.”
4. Take advantage of estate tax exemptions.
Chris Davis weighs in with straightforward guidance for wealthy business owners.
“Perhaps the simplest change in the tax reform, in terms of complexity, is the doubling of lifetime exemptions and generation-skipping transfer (GST) tax exemptions for SMBs, which will help in transferring ownership to heirs.”
Previously, the lifetime exemption was $5.5 million per person, or $11 million per couple. New rules allow for $11.2 million per person and $22.4 million per couple (indexed for inflation). So a business owner now has a much greater opportunity to bequeath the firm to future generations during life or at death without losing assets to taxes.
The only caveat, Chris warns, is that in 2026 the exemption caps are scheduled to revert to pre-tax-reform levels. “So what happens in 2026 if you’ve already made gifts in excess of the previous cap? The assumption is Congress would allow grandfathering according to the higher cap, but we will have to wait and see.”
5. Beware of unintended consequences of the legislation.
Finally, Mitchell and Chris warn of a couple unintended consequences of the tax reform that business owners should watch out for as they plan ahead.
Most importantly, net interest expense deductions for all business entities is limited to 30% of adjusted taxable income — and firms with various subsidiaries must pay special attention to avoid trouble.
The other consequence is softer, but perhaps more relevant to office culture: Generally speaking, companies will be able to deduct only 50% of the cost of food they provide employees to eat in the office as a means of increasing productivity or morale. After 2025, no deduction will be allowed.
Those are just a couple potential unintended consequences.The new tax code contains more than 500 pages, so firms will need to keep a watchful eye to make sure they abide all the rules while managing their businesses for continued success.