Many Americans can expect tax savings when filing 2018 returns

The Tax Cuts and Jobs Act, passed into law in December, is the biggest change in the tax code in more than 30 years. It is expected to result in tax savings for most Americans, without requiring them to do anything differently.

By now, most business people should at least be familiar with the basics of the major changes that came from this law as it relates to their personal tax situation:

• lower individual income tax rates
• an almost doubled standard deduction
• new limitations or elimination of certain deductions
• the loss of personal exemptions
• the expansion of the child tax credit.

Individual opportunities

The average taxpayer has a relatively simple tax situation: they work for an employer, perhaps have some investment income, and itemize deductions taking advantage of their mortgage interest, taxes and charitable giving. They also might have child care expenses or pay college tuition for their children that they’re eligible to claim tax credits for. These individuals will benefit from the lower tax rates and perhaps some of the other provisions of the new law. Many will end up paying less tax in 2018, assuming their tax situation stays about the same.

However, significant tax savings can be realized by the proactive individual who is savvy enough to either a) understand how the new tax law affects them, or b) has an accountant whom they rely on for this, and in either case, takes the necessary steps to perform proper tax planning.

This can include controlling the timing of their itemized deductions (particularly charitable giving or paying medical expenses) to maximize savings from the higher standard deduction, or a number of other strategies, such as using 529 college savings plans.

Business opportunities

Tax planning opportunities increase as complexity increases. With the corporate income tax rate changing to a flat 21 percent from the previous graduated system with rates as high as 35 percent, business owners should be taking another look at their entity structure to confirm their current situation is still the most advantageous.

McMahon and Associates prepares more than 500 entity returns, about 90 percent of which are pass-through entities, i.e., not subject to income tax at the corporate level. Based on our analysis, we do not expect a significant percentage of businesses to change their entity type due to the new tax law.

While C corporations might benefit from this new tax rate, they remain subject to double taxation—meaning that when after-tax profits are distributed to the shareholders, the shareholders are subject to tax on the distributions. This always has been one of the major disadvantages of C corporations. One situation where a C corporation can be beneficial is in the case of a large corporation that tends to retain cash for use in the business rather than distributing it to the shareholders.

A major new tax break is the 20 percent deduction on “pass-through” business income. Congress’s goal was to not only provide tax relief to C corporations, but to other types of businesses as well. This was accomplished through the creation of this new deduction, which is a major factor in most businesses choosing to maintain their current structure. Owners of S corporations, partnerships, most LLCs, and sole proprietors should become familiar with, and plan to maximize this significant deduction.

Other noteworthy changes

Depreciation expense: Businesses have a fair number of other changes to plan for as well, including the expansion of capital expensing options. Significant purchases, for example equipment and business vehicles, might qualify for an immediate 100 percent write-off in the year of purchase, saving taxes and improving cash flow.

Entertainment expenses: A major negative for some businesses is the elimination of the deduction for entertainment expenses. Client-focused businesses that do a lot of entertaining, will find they can no longer deduct these expenses for tax purposes. If these business owners are tax-minded, they might have already made changes to their marketing strategies to find tax-deductible alternatives.

Many business owners are accustomed to an annual pre-year-end meeting with their tax adviser to analyze the year-to-date results and map out a strategy to minimize their tax burden for the rest of the year. This year, however, planning is more important and more complex than ever. The rewards will be greatest for those who are prepared.

Click here to read more from the Oct-Nov-2018 issue of Northwest Indiana Business Magazine.