Last December the Tax Cuts and Jobs Act (TCJA) was signed into law. The new legislation is broad in scope and can potentially lower the tax burden on most U.S.-based businesses. But reaping the benefits requires understanding how deductions have changed and how your practice or medspa’s business entity and accounting methods impact its use of new deductions and tax credits. Following are some the key changes to consider as we enter the last quarter of 2018.
Under the TCJA’s “100 percent bonus depreciation,” businesses can now write off the full cost of equipment and property purchases—such as medical equipment, computers, fixtures, furniture and vehicles—in the year the equipment was placed in service. Pre-TCJA, businesses could only write off equipment cost depreciation over a number of years.
In addition, the first-year expensing write-off has been doubled from $500,000 to $1,000,000 and now includes fire protection, and alarm and security systems.
Equipment Abandonment. If equipment or other business assets have no value to your practice, abandoning rather than selling them might be more rewarding. Abandoning old equipment generates a fully deductible loss, rather than a capital loss subject to limitations. To claim this deduction, abandonment of the equipment must be true and documented before the end of the tax year.
Entertainment Deductions. Business-related entertainment, amusement or recreational expenses are no longer deductible. Business meals remain 50 percent deductible.
Family and Medical Leave Tax Credit. As part of the TCJA, employers can claim a tax credit—a reduction in the operation’s tax bill (as opposed to a deduction in the income that tax bill is based on)—on wages paid to qualifying employees while they are on family or medical leave. In order to claim the credit, there must be a written policy that provides at least two weeks of paid leave annually to all qualifying employees who work full time. What’s more, leave pay must be no less than 50 percent of the wages normally paid to the employee.
Business Interest Deductions. The TCJA placed new limits on business interest deductions, restricting them to 30 percent of the operation’s adjusted gross income. Questions remain about what constitutes “investment interest” vs. “business interest” and how the limit should be applied to pass-through entities and consolidated groups. (Corporate debt is considered to be business interest rather than investment interest.) Fortunately, there is an exception for small businesses with gross receipts that fall below a $25 million threshold for a three-year period. If your practice meets these parameters, you can write off the interest on loans obtained to start or expand your operation, hire workers and/or increase paychecks.
NOL Carryovers. Deductions for capital losses, net operating losses (NOLs), home office deductions and even large charitable donations that cannot be fully used in one year may be carried forward to future years. Under the TCJA, the maximum NOL deduction for a tax year is whichever is lower: the aggregate of the NOL carryovers up to the current year plus NOL carrybacks to such year, or 80 percent of taxable income. Additionally, most businesses—including practices and medspas—can no longer carry back NOLs.
The Pass-Through Conundrum
The federal tax rate for incorporated practices is now 21 percent. But if you are the owner of a “pass-through” business, such as an “S” Corporation, sole proprietorship or partnership, you may end up paying a higher rate when you claim the income on your individual tax return. To help even the playing field, the TCJA created a 20 percent deduction for qualified business income earned from pass-through businesses. If your taxable income exceeds $315,000 for a married couple filing a joint return or $157,500 for individuals, the deduction is subject to limitations based on the type of business, the taxpayer’s taxable income and the amount of W-2 wages paid by the business or practice.
Owners of pass-through businesses also need to pay close attention to changes in the personal income tax rules, including the removal of the personal exemption as well as deductions for state and local income tax, and the increased standard deduction.
As the end of the tax year approaches, there are some general rules that can guide practices to real tax savings year after year. They include:
Don’t spend money simply to reduce that tax bill. With tax credits and deductions, $1 spent does
not equate to $1 saved. Also keep in mind that if accelerated deductions result in a net operating loss (NOL), it can only be used to offset tax bills down the road. As mentioned above, there is no longer
an NOL carryback.
Know thy accounting method. Most year-end tax strategies work best for cash-basis taxpayers vs. accrual-basis businesses. An accrual-basis practice reports all income in the year it is earned and all expenses in the year incurred; a cash-basis practice records income as it is received and expenses as they are paid. So if you are an accrual-basis business paying for a 2019 expense in 2018, you are not entitled to a deduction on the 2018 tax return.
Perform a “pro forma” analysis before making any changes or large expenditures. Use estimated income and expense figures to forecast the practice’s tax liabilities for 2018 with the new rules, deductions and credits. Otherwise, the true impact of “reform” will not be known until the tax return is prepared—when it may be too late to make any moves to reduce your tax burden.
Re-examine your business entity. Based on the new rules, practices may be able to achieve significant tax savings by changing the entity used to file its tax returns from a “C” Corporation to a pass-through entity or vice versa. This process does take time, so now is the time to run the numbers.
Above all, if your tax professionals are not already involved in your year-end tax planning process, now is the right time to enlist their aid.
Mark E. Battersby is a freelance writer who specializes in tax and finance topics.
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