What you should know about the new tax law

In late December, the most sweeping tax reform act since the 1986 overhaul put forth by President Ronald Reagan has been signed into law. So, what does it mean for you? No matter what side of the political spectrum you come down on, there is a lot here to digest, so here is a rundown of the most relevant provisions affecting our friends and clients in the pest management and lawn care businesses.
 

The “Make America Great Again” Provision

The C Corp rate was lowered from a maximum of 35 percent to a maximum of 21 percent. This is the most far-reaching reduction of taxes in the legislation. While it won’t affect most of us in our businesses, it is believed that by lowering this rate for large corporations, they will reinvest the savings into creating jobs. On the other side, many believe that this is false and that big corporations will only buy back stock or pay dividends to shareholders.

Either way, a buyback will increase the value of stock and or dividends paid to stockholders, and will thus give those stockholders more money. If people (stockholders) feel wealthier, there is an income effect. Remember when stocks were at all-time highs in the late 1990s? 401Ks and other pensions were at high valuations, so average Americans felt wealthier and spent more and our domestic economy was on fire. This was under the Clinton presidency – not to be political here, but my point is under either Republican or Democratic leadership, if you prop up large corporate valuations, you in turn charge up the economy for the average American.

It’s for this reason, I believe, that this tax cut on C Corps will be good for the U.S. economy, and will make our economy more competitive globally. That said, this decrease in corporate tax rates is largely irrelevant to our specific clients and friends, as it does not in itself lower taxes for small businesses.

Why? Well, in most cases the lowering of the corporate rate won’t help small businesses. It’s also why most small businesses should not be organized as a C Corp: Under prior law, as well as the new law, it would not be prudent for privately held corporations to be classified as C Corps, as profits are taxed at the corporate level and again at the individual level when distributed to owners with payments known as dividends. The cumulative effect of this double taxation would result in larger tax liabilities for owner/shareholders of profitable businesses. The solution is for small businesses to be organized as a “Pass Through.” Entities known as “Pass Throughs” come in the form of partnerships, limited liability companies (LLCs) and S Corps. For more, see my TurfBooks blog post on entity selection.

If your company is organized as a C Corp, there are many reasons why you may want to consider a “Pass Through.” If you are organized as a C Corp, feel free to contact us to do an analysis to see if it makes sense to switch.
 

How will the new tax law affect me personally?

Individual tax rates have been lowered. he current individual tax brackets are being adjusted downward such that taxes paid based on taxable income will be less for individuals than the current tax brackets. Sounds good, right?

Not so fast. Many of our deductions will be limited, which may serve to increase our taxable income, which in turn will cost more in taxes. The largest limitation that is getting the most play in the media is the state and local tax deduction (SALT), which is capped at $10,000. Unfortunately, this is a “biggie,” as state income taxes and real estate taxes usually amount to quite a bit more than $10,000. In certain states, a $10,000 limitation disqualifies a very large deduction that folks have used in the past to significantly reduce their tax burden.

While the new tax law was passed almost completely along party lines, it should be noted that some of the small minority of Republican Congress representatives who voted against it came from New York, New Jersey and California – states with very high SALT.

Continuing with the itemized deduction limitations, the mortgage interest deduction, which was capped at $1 million, will be reduced to $750,000. Don’t worry if you currently have a mortgage of up to $1 million that was written prior to Dec. 15, 2017, and closed by Dec. 31, 2017; you are grandfathered in. In addition, home equity loans will no longer be deductible.

It sounds like our itemized deductions are getting crushed. They are, but part of the law has raised the standard deduction from $13,000 to $24,000 for a married couple. This is a “gimme” that an individual can automatically take rather than deducting itemized deductions. So, in the future, about half of all taxpayers who used to itemize, won’t need to anymore and will take advantage of the increased standard deduction.

The issue, though, is that many who in the past had far more than $24,000 of itemized deductions through SALT and mortgage and home equity interest deductions will see most of those deductions disappear — and in turn, probably pay more in taxes.

Here are a few more items of note that might affect you personally:

• Repeal of the personal exemption. Under the old rules, taxpayers received an exemption in the amount of $4,150 for each family member — so for a couple with two kids, $16,600. Under the new law, however, personal exemptions have been eliminated.
• Alternative minimum tax (AMT). Taxpayers with certain deductions are required to compute taxable income under an alternative code, and if the resulting tax liability is higher using this method, they are subject to the higher tax. For most of our clients and friends who are in AMT, it’s caused by higher SALT. The new law, while retaining AMT, raises the exemption limit for the AMT calculation from $208,400 to $1 million for a married couple filing jointly. This will reduce the number of taxpayers subject to AMT drastically.
• Alimony deductibility. Under the old rules, making alimony payments were deductible to the payor and taxable to the payee. For divorces signed after Dec. 31, 2018, there will be no deduction. Nor will payments be taxed to the payee. This is likely to make divorce planning trickier, as the payor is usually in a much higher tax bracket than the payee and therefore this provision will add additional revenue for the government while increasing the combined tax bill for a divorced couple.
• Child tax credit. Under prior law, a tax credit in the amount of $1,000 per child was phased out beginning at $110,000 for joint filers. The new law increases this credit to $2,000,with the phase out for joint filers beginning at $400,000.
• Health insurance. The individual mandate under the Affordable Care Act (ACA) is repealed. This means that an individual will not have to pay a fine for not having health insurance. However, the company mandate has not been touched, and is still intact for those firms employing more than 50 employees and thus must provide insurance for employees.

“Pass Through” entities

Currently, taxation of “Pass Through” entities (sole proprietorships, partnerships, LLCs and S Corps) is based on individual tax rate brackets. Under the new law, “Pass Throughs” are still taxed at the individual level. However, there is a deduction allowed for 20 percent of pass-through income. However, to prevent owners of “Pass Throughs” from reducing their W-2 wages, thereby increasing pass-through earnings that qualify for the exclusion, a limitation on the deduction is phased in based on W-2 wages above a threshold of taxable income.

Generally, the deduction is limited to 50 percent of the W-2 wages paid by the business. The pass-through exclusion is available for pest control and lawn care operators, manufacturers, distributors and real estate firms, among others. But it is not available for professional firms such as lawyers and accountants at certain income levels. (Go figure! Congress, made up of mostly lawyers, limits the deduction on professional service firms.) If you are not organized as a “Pass Through” entity at this point, you should seriously think about it for 2018.
 

Equipment purchases

• Bonus depreciation. The new law extends and modifies bonus depreciation, allowing businesses to immediately deduct 100 percent of the cost of eligible property in the year it is placed in service, through 2022. The amount of allowable bonus depreciation will then be phased down over four years: 80 percent will be allowed for property placed in service in 2023; 60 percent in 2024; 40 percent in 2025; and 20 percent in 2026. The new law also removes the rule that made bonus depreciation available only for new property; therefore, used equipment now qualifies.
• Sec. 179 expensing. The new law has increased the maximum amount a taxpayer may expense under Sec. 179 to $1 million, and increased the phaseout threshold to $2.5 million. These amounts will be indexed for inflation after 2018. The new law has also expanded the definition of Sec. 179 property to include any of the following improvements to nonresidential real property: roofs; heating, ventilation and air-conditioning property; fire protection and alarm systems; and security systems.
• Interest deduction is limited. Business interest used to finance equipment, accounts recievable (A/R), and credit lines will be limited to business interest income received plus 30 percent of earnings before interest, taxes, depreciation and amortization (EBITDA). This will limit a firm who is marginally profitable or shows a loss to borrow in order to bring that business back to health or grow the business.
• Net operating loss (NOL) deduction. Under prior law, a business that sustained a NOL could deduct 100 percent of that loss against future income, up to 20 years. The business could also carry it back two years, amend those tax returns and get an immediate refund of taxes to help through troubled times. The new law removes the ability to carry back an NOL, and only allows an 80 percent reduction of income for future years. However, the loss may be carried forward indefinitely.
• Estate tax. Currently, estates become taxable at the $5.6 million level ($11.2 million for husband and wife). The new law doubles those amounts. This could be a very large tax savings to those family businesses who are passing ownership to the next generation or selling their business and passing on the proceeds.

While there are many other aspects to the new law, the above summarizes the key aspects that will affect our clients and friends. Based on what I’m seeing, most of our friends and clients will not be saving much under the new plan — and in many cases, they may see a rise in their taxes. However, there are many tax planning opportunities that should be put in motion now in order to save on taxes in the future. Feel free to call us to help!