What to Expect From the New Tax Code: New QBI deduction expected to have ‘major impact’ on business owners
Passed in a 51-48 Senate vote last December, the Tax Cuts and Jobs Act is the biggest change in United States tax administration in decades. From deduction tweaks to a controversial repeal of the Affordable Care Act’s individual mandate, the law will change tax planning strategies for individuals and businesses alike.
To get some insight on how taxpayers and businesses should be preparing for the new tax law, the Traverse City Business News consulted five local tax and accounting experts (pictured l-r): Larry Williams of L.E. Williams & Company; James Taylor and James West, both of Dennis, Gartland & Niergarth; Rick Harris of Harris Group; and Scott Verhage of Kindlinger & Co.
What, if anything, changed this past tax season?
Williams: I think it’s primarily 2018 (that most of the changes to the tax law go into effect). And some things won’t change until 2019. For example, the penalty for not having health insurance isn’t removed until 2019.
Harris: This past tax season, we had to educate our clients on the changes that are coming and then start a very basic tax planning strategy for the 2018 year. The addition of the new qualified business income (QBI) deduction will have a major impact on our clients, so we wanted them to be prepared. To assist and educate our clients, we held two webinars explaining the changes for individuals and business owners.
West: [W]e got a lot of questions from clients wondering what next year is going to bring.
Taylor: There were a few rules that went into play in 2017, but those were mostly pretty obscure. The vast majority of the rules went into effect as of Jan. 1, 2018.
What are the biggest changes on the way?
Williams: The biggest change relates to both of them and that’s going to be the deduction for QBI. This entire reform started with the reduction in the corporate tax rate from 35 percent to 21 percent. And by corporate tax rate, we’re talking about C corporations. In the small business world, there aren’t very many of those anymore. So most of the businesses now operate as some kind of flow-through entity [Schedule C, partnerships and S corporations], and this QBI deduction is the government’s way of passing the corporate tax rate reduction on to individuals that own flow-through entities. The QBI deduction is to subtract 20 percent of qualified business income from individuals’ gross income before taxable income is figured.
Harris: For individuals, most every tax bracket has changed, thus lowering the overall tax burden. Also, increase in the floor of the standard deduction means many basic return filers will no longer qualify to use itemized deductions, thus making their return easy to complete in some instances. For businesses, the largest change is the QBI deduction, which will have a significant effect on most businesses.
Verhage: For individuals, the standard deduction almost doubled. It increased from $12,700 to $24,000 for married couples. Itemized deductions have also been restricted. For example, the tax deduction for the combined property taxes and state and local income taxes is limited to $10,000, and miscellaneous itemized deductions have been eliminated.
The law made the biggest changes to business tax law. The changes are far reaching, but poorly defined because the IRS has not provided any official guidance. For C corporations, the tax rate is 21 percent for tax years beginning after Dec. 31, 2017. Corporate alternative minimum tax (AMT) is eliminated. For non-corporate entities, there is a new deduction of up to 20 percent for QBI. For assets put in service before Dec. 31, 2022, the first-year bonus depreciation is equal to 100 percent of the asset cost for new and used personal property. The Section 179 depreciation deduction has also been increased to $1 million. The entertainment deduction has been eliminated.
West: For individuals, the big thing is that they are going to lose a lot of their itemized deductions, due to the caps on state and local taxes.
Do you expect most of your clients to benefit from the changes?
Williams: The expectation generally is for most people to pay less tax. But there’s no such thing as a ‘most person.’ The new tax code will hit everybody differently. So, short-term, it makes tax planning more complicated. But long-term, a lot of people will pay less tax.
Harris: When we did our basic tax projections, almost all of our clients were going to benefit from the changes in the tax code. The clients that did not benefit had a large amount of miscellaneous itemized deductions, such as unreimbursed employee expenses like mileage.
Taylor: I think most businesses will benefit from the new tax code because most businesses are flow-through entities. The exception might be professional service firms that have limits under that new rule. [Professional service firms include businesses in fields like law, insurance, and financial services.] Outside of that group, though, I think a lot of business owners do benefit. On the individual side, it’s hard to gauge the percentage of winners and losers. It’s really based on the facts and circumstances pertaining to each individual. We will probably see some more statistics come out about that after the 2018 filing season.
West: The ones who won’t benefit as much are the individuals that don’t have their own business, get W-2 wages and have higher incomes, because they won’t receive the itemized deductions that they would have previously had.
What will be the biggest challenge of the new tax bill for your clients? How can they prepare?
Williams: Some of the things that might drive tax planning are a little bit different. Some people used to bunch up their itemized deductions. For example, with property taxes, if you didn’t pay last year and then this year you paid two years’ worth. Some people who were kind of marginal with itemized deductions would try to push them like that, so that every other year they had extra. With the new standard deduction threshold of $24,000 on a joint return, it’s going to be harder for most people to do that.
Harris: Our biggest concern for clients was planning their 2018 estimated tax payments, since most will see a reduction in total tax obligation. We didn’t want clients to significantly overpay their obligation, thus giving the government a free loan. But if you underpay your estimated payments, you will be subject to underpayment penalties. So we will be doing significant tax planning with our clients to be sure they fall into the safe harbor.
Verhage: For business owners, planning is more important than ever. Wages, type of retirement plan and timing of expenses all must be reviewed. The tax law is multi-year; the analysis of your tax situation needs to be multi-year, too. I would recommend working with a trusted advisor as early as possible.
Taylor: For our business clients, we need to take the changes into account when we’re doing our tax planning for year-end. So that’s probably the biggest thing that we’re looking at right now: making sure we’re talking to all of our clients. Business owners should talk to their CPAs and make sure they are getting tax planning for 2018. It’s all about knowing what to expect going into this tax filing season so that you’re not surprised.
What will be the biggest challenge for professional tax preparers?
Williams: To a certain extent, we relearn the tax code every year. It’s not unusual to have a thousand pages or even a couple thousand pages of tax law changes, by the time you include the rules, regulations, instructions, examples and all of that stuff. So one of the things that we have always had in the business is that, as a CPA, one of the requirements to maintain our CPA license is continuing education. We have always been required to do a minimum of 40 hours of continuing education per year. That requirement has not changed, so some of those hours will be spent learning about the new tax law and what to expect.
Harris: The misperception that the tax code changes will make the preparation process easier. For some, basic individual returns, yes, it will be more simplified. For anyone with a business, though, the tax code is more complex.
Verhage: The biggest challenge for tax professionals is the changes to the law are very complicated but not clearly defined. The IRS has yet to provide guidance in most areas of the new law. We need to make sure that we stay up on pronouncements to ensure we can provide the best advice for our clients.
West: Currently, there aren’t enough regulations out to give us guidance on a lot of the laws that were passed. We’re kind of stuck wondering what it’s all going to turn out to be according to the IRS regulations.
Jim: Interpreting the rules is the big one. Some of the rules are brand new. This was a pretty wide, sweeping change to the tax code. It didn’t create a ton of new rules, but it tweaked a lot of them and the ones that are new are pretty substantial. So they require additional guidance from the [United States Department of the] Treasury as to how those rules are being interpreted. That’s what practitioners are waiting for.