Should You Choose a Different Business Structure After the Tax Cuts and Jobs Act?

The Tax Cuts and Jobs Act was passed by Congress in November of 2017 but did not take effect until the beginning of this tax year (2018). It brings enough significant change to the tax code to prompt the question, “Should I choose a different structure for my business to take full advantage of this new law?” Our answer: “Yes, No, Maybe.”

Fortunately, those are the only three choices. Unfortunately, these otherwise simple choices become more complicated when associated with the tax code. As you can probably imagine, one size does not fit all when it comes to tax planning.  It never did.  And, with the Tax Cuts and Jobs Act, one size doesn’t even fit one size anymore.

For instance, if you’re a business owner whose company is structured in any way other than a C-corporation, you might be aware of the new “Qualified Business Income Deduction.” With the Qualified Business Income Deduction, you get to deduct 20% of your flow-through business income on your personal tax return and pay tax on 80% of the business income. Sounds simple, right? This section of tax law has more restrictions and limitations – we’ll call them “weeds” – than Round-Up could ever hope to control, but we’ll keep the explanation that simple to gain a general understanding.

If your business is a Sole Proprietorship with no payroll and no assets that nets $200,000 – absent of any “weeds” – you get a whopping $40,000 deduction and pay tax on only $160,000 of your net income.  Since a sole proprietorship does not differentiate between the business and the owner, the owner is entitled to take the full $200,000 “out of the business” without any tax consequences.

Ah, but now here comes a “weed.”  Corporations are required to pay salaries to the owner for the money they take out of the business. Partnerships must classify the money the owner takes out for services as “guaranteed payments.” Both salaries and guaranteed payments do not qualify for the 20% deduction mentioned above.

Therefore, if the Corporation or Partnership has the same $200,000 net annual income, and they pay a salary (Corporation) or guaranteed payment (Partnership) of $80,000, then what remains eligible for the 20% deduction is the $120,000 bottom line business income. So, a business organized as a Corporation or Partnership, doing the same exchange for services as a Sole Proprietorship, netting the same annual income, will only qualify for a $24,000 deduction. The only difference between the three? Their business entity structure.  And so, one size – each one is a business — isn’t truly one size under the Tax Cuts and Jobs Act.

By now you’re probably thinking, the best recommendation would be to structure your business as a Sole Proprietor if your business type allows for that to make sense. Yes, but, what happens when the business is even more profitable than $200,000 per year? Let’s say that in 2019, you net $500,000 (before salaries or guaranteed payments). That’s when the “weeds” really take over, and their explanation would require a dissertation, not a blog post. Take our word for it. With such an increase in income, under the Tax Cuts and Jobs Act, the Sole Proprietor, and Partnership businesses would not qualify for any deduction. And yet, an S-Corporation that is the same business, providing the same services, netting the same income, would qualify for a $62,500 deduction.

So, not only is “one size fits all” a thing of the past. “One size” isn’t even “one size” from year to year. What happens when your Sole Proprietorship profit is low one year and high the next? You can’t switch business entities each year based on projected income. So, based on the current realities of the tax code, what is the wisest move for a business owner? Absent any other information, the recommendation would be to do business as an S-Corp.

This new tax code will affect every business in the United States, regardless of size or entity structure, which is how we arrived at our initial answer to the question, “Should I change my business structure under the Tax Cuts and Jobs Act?” is “Yes. No. Maybe.”

Let’s find out what entity will be right for you. Contact us online or call 215-723-4881 to schedule a consultation.

New Sales Tax Laws Effective 8/1/16

On July 13, 2016, Governor Tom Wolf signed into law Act 84 of 2016. Per the Pennsylvania Department of Revenue, the following updates have been made to Sales, Use, and Hotel Occupancy taxes:

Timely Filing Vendor Discount
Effective for returns that have a period end date after August 1, 2016, the vendor discount for licensees for timely filed returns and payments is limited to the lesser of $25 or 1 percent of tax collected for a monthly filer, $75 or 1 percent of tax collected for a quarterly filer and $150 or 1 percent of tax collected for a semi-annual filer.

Exemptions
Effective July 1, 2017, property and services directly and predominately used in “timbering” by a company primarily engaged in the business of harvesting trees is exempt from tax. The term shall not include the harvesting of trees for clearing land for access roads.

Effective immediately, licensees are not required to collect tax on corrugated boxes used by a person engaged in the manufacture of snack food products to deliver the manufactured product, whether or not the boxes are returnable.

Effective in 60 days, the sale at retail or use of services related to the setup, tear down, or maintenance of tangible personal property rented by an authority to exhibitors at the Pennsylvania Convention Center and the David L. Lawrence Convention Center is exempt from sales and use tax.

Sales tax base expansion
Effective August 1, 2016, licensees are now required to collect tax on digitally or electronically delivered or streamed video, photographs, books, any other taxable printed material, apps, games, music, any audio service including satellite radio or canned software. These items are taxable whether accessed and purchased singly, or by subscription or in any other manner. Any maintenance, updates or support on these items are taxable.

Taxable sales on these items made on or after August 1, 2016, must be included when filing sales tax returns. The date of sale is the date of the invoice or other similar document.

Sales Suppression
Any person who, for commercial gain, sells, purchases, installs, transfers or possesses in this commonwealth an automated sales suppression device or zapper that the sole purpose of the device is to defeat or evade the determination of sales tax due commits a punishable offense.

Anyone that commits such an offense and is in possession of three or fewer devices will be subject to a fine up-to but not to exceed five thousand dollars ($5,000).

Anyone that commits such an offense and is in possession of three or more devices will be subject to a fine up-to but not to exceed ten thousand dollars ($10,000).

This shall not apply to an entity that possesses an automated sales suppression device for the sole purpose of developing hardware or software to combat the evasion of taxes by use of automated sales suppression devices or zappers or phantomware.

For additional information or if you have any questions regarding this notification, contact the Taxpayer Service and Information Center at 1-717-787-1064, or visit the department’s website at www.revenue.pa.gov, and click on Online Customer Service Center; Service for Taxpayers with Special Hearing and/or Speaking Needs is 1-800-447-3020 (TT only).