How the Tax Advice for Your Business May Change in 2018

How the Tax Advice for Your Business May Change in 2018

In the April issue of Speaker magazine, we gave you four steps to take to prepare for the changes you will face from the Tax Cuts and Jobs Act of 2017 (TCJA). Several NSA members who are CPAs, some of whom train CPAs on tax return preparation, put together just one example of how you might be affected.

Read this, but then take our advice. Hire a professional to help you make needed changes. A lot is still up in the air, so ask your tax professional when would be the best time to meet, probably no later than the end of summer.

One of the least clear aspects of the TCJA is the Qualified Business Income (QBI) deduction for pass-through entities. This will apply to taxpayers whose business is a Sole Proprietorship, LLC, S Corporation or Partnership. The only active business entity this does not apply to is a C-Corporation filing an 1120 because the corporate tax rate was significantly reduced.

There are rules that the IRS will put in place, however, that will have to wait until they interpret the law, create regulations, and modify forms to implement the new law. The following example is our best guess for now and illustrates some of the possible issues:

  • A speaker has an S Corporation and has paid herself reasonable wages of $100,000.
  • The S Corp is 100 percent owned and, in addition to the wages of $100,000 reported on 1040 Line 7, passes $50,000 taxable income to the 1040 Schedule E, which is ultimately added to Adjusted Gross Income (AGI).
  • There is additional taxable income from rentals and spouse Social Security of $40,000.
  • They are filing Married-Filing-Jointly (MFJ) and the total taxable income is below $315,000.

Applicable provisions of TCJA:

  • The QBI deduction of 20 percent is allowed on “net income” after reasonable compensation is paid to the owners (wages or guaranteed payments).
  • There is an exception, called the “specified services limitation,” that limits the QBI when the business is primarily based on the skill and reputation of the owner or business, which the CPAs consulted with believe applies to most speaking/consulting/coaching businesses.
  • The “specified services limitation” does not apply when total taxable income is below $315,000 and starts to phase out from there.

Conclusions for this example:

  • Since reasonable compensation was paid to the owners, and since total taxable income is below $315,000, the QBI is $50,000.
  • The QBI deduction would be $10,000 from taxable income.

What would change that answer:

  • If MFJ taxable income exceeds $415,000, the QBI deduction would be zero because the business is subject to the limitation for “specified services” and exceeds the threshold below which the limitation does not apply.
  • If the IRS does not believe that $100,000 is reasonable compensation, the QBI would be adjusted downward. We do not yet know how that will be determined, but if the speaker is paying themselves less than they pay their administrative assistant, assuming both are full-time, it may be difficult to make the case that it is reasonable.

I imagine the IRS will get much more interested in reasonable compensation to shareholders of these types of service businesses. And that tax advisors may change their suggestions about using guaranteed payments in partnerships or multi-owner LLCs.

Don’t take my word for it. Don’t put this off. Get specific advice from your tax advisor for your circumstances.

Linda Keith

Linda Keith

President at Linda Keith, CPA
Linda Keith, CPA, CSP, helps lenders say “yes” to good loans through in-person and online credit analysis training. She helps senior credit professionals achieve credit risk readiness for the next major disruption.
Linda Keith
Linda Keith