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Accounting - Tax reform

image Dustin R. Michalak, CPA, CVA Managing Shareholder, Barrett & Co., P.C., San Antonio, TX

AUSTIN - The passing of The Tax Cuts and Jobs Act is a historic accomplishment by lawmakers. The act, seemingly, will try to spur our nation’s economic growth and job creation by reducing the tax burden on all job-creating businesses. So what exactly does this mean for contractors? How will the new laws affect the way contractors run their businesses? How much TAX SAVINGS should contractors expect?

 

 

The most significant and most publicized change is the decrease in tax rates for both businesses and individuals. The focus for this article will stay within the business changes. For C-Corporations, tax years beginning after December 31, 2017, a flat tax rate of 21% will be applied to taxable income. This is a significant change from 2017’s maximum tax rate of 38%. Though this makes C-Corporation an attractive entity tax selection, there is still the burden of double taxation upon dividends to the corporation’s shareholders. The typical dividend rate will range from 15% to 23.8% depending on the shareholder’s individual earnings. Here is a simplified example:
    A C-Corporation with taxable income of $100 would pay $21 in taxes. If the corporation pays a dividend to a high-income shareholder of the remaining $79, the shareholder will pay an additional $18.80 in taxes. Effectively paying $39.80 ($21 + $18.80) in taxes at a rate of $39.8%.
    For pass-through entities, things get a bit more complicated, although beneficial for tax purposes. What type of businesses are qualified as pass-through entities?  These are Partnerships, S Corporations, LLCs taxed as partnerships, and sole proprietorships. Under the new law, beginning in 2018, pass-through entities may qualify for a deduction up to 20% of qualified domestic business income subject to certain limitations based on taxable income. The limitations are phased in for taxpayers with taxable income of $315,000 married filing jointly (“MFJ”) and $157,000 for all other filers. Qualified business income (“QBI”) is defined in section 199A(c) as ordinary income less ordinary deductions from a qualified trade or business. Qualified business income does not include capital gains and losses, dividend, or interest income. Any potential deduction is taken at the taxpayer level. Here is a simplified example for a taxpayer who is under the phase out:
    A high-income taxpayer with $100 of qualifying business income would get a deduction of $20. The remaining $80 of income would be taxed at 37% (highest individual rate).  The taxpayer would owe $29.60. Thus, the taxpayer would have an effective rate of 29.6%.
    The calculation of the pass-through deduction for taxpayers above the taxable income threshold is more complicated. In this case the 20% deduction is further limited based on the W-2 wages and capital of the business. The deduction is limited to the greater of the following: (a) 50% of the wages paid by the business, or (b) 25% of the wages paid by the business, plus 2.5% of the unadjusted basis of all tangible depreciable property of the business.
    What type of entity should my business be and how should the earnings be taxed? Unfortunately for contractors, there is not a clear cut answer. It will all depend on the business as well as the owner’s investment objectives, bonding requirements and other considerations. This question will need to be answered on a case by case basis. 
    Another hot topic item for contractors is depreciation and more specifically, Section 179 expense and Bonus Depreciation. The depreciation changes in the new law can add huge tax savings, especially for contractors with extensive equipment and capital expenditure requirements. For tax years beginning after December 31, 2017, taxpayers may expense up to $1 million under Section 179, and the phase out threshold amount is increased to $2.5 million.  These amounts will be indexed for inflation in tax years beginning after 2018. In regards to Bonus Depreciation, for qualified property placed in service between September 27, 2017, and January 1, 2023, taxpayers are allowed a 100% Bonus Depreciation deduction on both new and used qualified property.
    The new tax reform bill includes other changes that effect contractors such as, accounting for long-term contracts, reporting under the cash method, non-deductible entertainment, deductibility of interest expenses and many other changes. It’s extremely important that contractors contact their tax advisors now to understand the effects this tax reform has on their businesses and evaluate the company’s entity selection to take advantage of the changes.


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Lexie Velasquez lexie@constructionnews.net