How could new federal tax cuts impact small business?

The tax reform congressional conference report is 1,097 pages. There is no way to cover all the impacts here, but my goal is to provide an overview of the biggest changes to business owners.

In general, income tax rates have decreased. However, not every business owner will receive an income tax cut. There are a lot of changes to many parts of the income tax code, and two people with relatively similar business situations could see different impacts due to personal situations, such as mortgage interest, number of children, etc.

Exact impacts are tough to predict without running an income tax projection specific to an individual’s situation.

The approach to taxing business income has fundamentally changed. Impacts are different based on whether a business is a C corporation or flow-through entity. A C corporation’s income will be taxed at a flat 21 percent. In the past, C corporations have not been that attractive, as money pulled out of them is also taxed as dividends at the individual level. However, with the reduced corporate rate, it may be worthwhile to evaluate which tax structure makes the most sense.

If a business is taxed as a flow-through entity (S Corporation, partnership or sole proprietorship), that income will be given a preferred tax rate, with certain rules and limitations. Generally, that pass-through business income receives a 20-percent deduction of the business income. In essence, 20 percent of your business income is not taxed to give business owners a preferred income tax rate.

However, when taxable income exceeds $315,000 for a married couple ($157,500 for other filing statuses), deduction phase-outs begin to kick in. For service businesses, the phase-out begins the elimination of the 20-percent deduction. For non-service businesses, the phase-out caps the 20-percent deduction at 50 percent of W-2 wages, or 25 percent of wages and a formula based upon tangible assets.

Due to this preferential business income treatment, some employees may ask to become independent contractors. You should determine if your situation even allows for that, and the employee should also consider the impact of self-employment taxes.

Other changes that could impact business owners are that interest deductions are limited to 30 percent of business earnings before interest, taxes, depreciation and amortization, and some employee benefits will no longer be able to be provided to employees tax-free or at a 100-percent deduction.

What should business owners do in response to tax reform?

If you’ve only had income taxes prepared - but never planned for them - this is the year to start. If you have planned in the past, you should do it again with a different pair of lenses. Everyone should have serious discussions and analysis on how they are structured to optimize their business for the new tax code. Any professional fees you encounter will be well worth it, either in tax savings or reducing the unknown and creating certainty regarding your 2018 (and beyond) tax situation.

You shouldn’t wait until the end of the year; take action now to optimize your situation for the entire year. This act was sold as tax simplification, and it has achieved that at some level by reducing the number of individuals who will itemize deductions like mortgage interest and charitable contributions. But the business tax code changes are anything but simplified. With complexity comes a greater opportunity for planning and shaping your tax situation.

What new technologies do you recommend for managing finances?

Dashboard tools simplify the monitoring of finances, as well as generating alerts. You can use more generic off-the-shelf products and services, or custom software like we have had developed. Dashboards can pull data from multiple sources, give you piece of mind and turn a bunch of manual processes into usable and actionable data.

QuickBooks Online currently has some Lab features available to CPA firms that will be rolled out to the public, including invoicing directly from email and “smart scanning” your accounting records for problems. Artificial intelligence will greatly impact financial accounting within the next five years. Less time will be needed to pull together and check data, and more time can be spent on developing business strategies using more accurate and timely data.

Lots of automation options are becoming available around business functions. Zapier has a tool that lets various applications communicate with each other and allows for automation in a workflow involving multiple applications. If a company adds a new 1099 vendor, the zap emails a request for the W-9 tax ID document, tracks when it has been uploaded, and notifies the appropriate people along the way.

What is the most common accounting mistake business owners make?

Frequently, business owners don’t have the time or aptitude to give business accounting the attention it deserves.
And even those with the aptitude should be spending their time on higher-value activities.

Common mistakes include: misclassifying the purchase of business assets as expenses; misclassifying the principal portion of payments as an expense; and misclassifying inventory purchases as cost of goods sold. These mistakes can materially impact how businesses calculate profits, which could lead to poor decision making.

Business owners should plan for taxes to know what cash flow their taxes will require and shape their tax situation as optimally as possible. They should be more proactive by setting financial goals, monitoring Key Performance Indicators and utilizing budgets to keep them on track.

What can business owners do to manage changes to health insurance premiums?

They should work with a benefits advisor to ensure they are making the appropriate options available to their employees at the most reasonable costs possible. As of January 2017, Qualified Small Employer Health Insurance Arrangements could be an option for reimbursement of medical expenses and insurance premiums.

Employers must look long and hard at what portion the company pays versus the employee. While these can be difficult conversations, the employer does not have to bear the entire burden of increased costs.

Adam Shay, CPA (N.C. License Number 35961), MBA, is managing partner of Adam Shay CPA, PLLC. He focuses on minimizing taxes and improving the financial results of entrepreneurs, and is actively involved in supporting the Wilmington entrepreneurial and startup community. For more information, visit http://www.wilmingtontaxesandaccounting.com/ or email him at [email protected]. He can also be reached by phone at (910) 256-3456.