Tax reform and the impact to your franchise
March 15, 2018
Tax reform is here, it’s big, and it will impact your franchise. As the first major overhaul of the country’s tax code since 1986, the Tax Cuts and Jobs Act is bringing with it substantial, wide-sweeping changes to business taxes, credits and deductions. With topics like entity selection, C-corp versus S-corp and LLC, and the qualified business deduction (QBI) headlining most business-related news, you may be feeling a little overwhelmed with what’s to come over the next year. Before jumping to change your entity or your business structure, you will need to consider the long-term impacts this could have on your franchise.
First, it is necessary to understand the highlights of the Act which are likely to impact you and/or your franchise. Those highlights include:
- The seven individual tax bracket rates are now: 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent and 37 percent, replacing the previous seven rates and a top tax rate of 39.6 percent.
- The top 37 percent individual tax rate applies to taxable income of over $600,000 for taxpayers filing joint returns. Previously, the top rate of 39.6 percent applied to income of greater than $470,700 for married taxpayers filing joint returns.
- Effective in 2018, the standard deduction is essentially doubled to $24,000 for married filing joint taxpayers, however the bill repeals personal exemptions.
- Effective in 2018, the itemized deduction for real property tax and state and local income tax is limited to a combined total of $10,000.
- Itemized deductions are allowed for medical expenses greater than 7.5 percent (rising to 10 percent in 2020) of adjusted gross income.
- The adjusted gross income percentage limit for charitable contributions increases from 50 percent to 60 percent.
- The mortgage interest deduction was limited by reducing the amount of new debt eligible for the deduction to $750,000 from the prior limit of $1 million.
- The individual alternative minimum tax (AMT) was continued, but the AMT exemption was increased to $109,400 from $86,200 for joint files, and the income level at which the exemption phases out was increased. When this increased exemption is combined with the limit on state income and local property tax, the effect of the AMT will be much less than in past years.
- Effective in 2018, the agreement provides a flat 21 percent C-corporation tax rate and repeals the corporate AMT.
- Business income taxed to an individual may be subject to a lower effective tax rate than the individual tax bracket rates described above. The reduction in rates is accomplished through a new deduction of 20 percent of qualified business income, which is the net amount of income, gain, deduction and loss with respect to a business activity. This includes passthrough entities as well as sole proprietorships. For income eligible for this 20 percent deduction, the effective maximum rate would be 29.6 percent (a 20 percent reduction of the 37 percent top individual rate). The deduction is generally limited to 50 percent of wages paid by the business or 25 percent of the wages paid plus 2.5 percent of the unadjusted basis of its depreciable fixed assets. However, this limit does not begin to phase in for married filing joint taxpayers until taxable income exceeds $315,000 and is fully phased in at $415,000. For certain personal service businesses, the 20 percent deduction begins to phase out as taxable income exceeds $315,000 for married taxpayers filing joint returns and is fully phased out when taxable income reaches $415,000.
- The Act allows 100 percent bonus depreciation of short tax life assets such as machinery and equipment for the next five years, and then phases out the 100 percent bonus depreciation over the subsequent five years. In addition, the Section 179 yearly limit is increased to $1 million with a phase-out starting at $2.5 million of additions.
One of the biggest questions the professionals at Honkamp Krueger & Co., P.C. (HK) have fielded since the signing of the Act is what to do about business entity selection. Should clients switch from S-corp to C-corp with the new rate? It seems appealing at the outset, but HK tax partner, Randy Mihm, CPA, JD, says, “Not so fast. When you add in the additional individual taxes that come with C-corp entity selection, you end up with a total tax rate of up to 51 percent. On the flipside, sticking with an S-corp selection, even at the higher initial rate, maxes out with additional taxes at 35 to 40 percent if you qualify for the QBI deduction.”
HK tax partner, Kevin Schmitt, CPA, CFP, says, “We always think about entity selection as more of an art than a science. It comes down to the individualized nature of each business and the nuances that come with your industry. It’s not a blanket selection that can be made lightly, and what we find most often when we perform a TaxGap Review is that entity is playing a huge factor in the savings we uncover for franchise owners. In light of recent tax reform, more than ever entity selection is a decision that should be made as a collaborative effort between you, your CPA and your attorney to determine the best structure for your franchise.”
The TaxGap Review factors in the corporate tax rates with your additional state and local tax rates to give you a clearer picture on what’s to come for your business in 2018. With recent tax reform, HK has re-vamped this popular review to TaxGap 2.0.
If all of these changes have your head swimming and pondering the future implications for your franchise, the complimentary TaxGap 2.0 can help. Through this review, HK will take an initial look at your current tax situation and seek out any potential hidden savings. The professionals at HK have been conducting these reviews for years and in 80 percent of cases have found savings for franchises, some totaling in the tens of thousands annually
To learn more about TaxGap 2.0, call 888-556-0123 or fill out our form.
This article was previously published in Franchising USA magazine.