Numerous corporations in the United States are cheering the passage of H.R. 1, known as the Tax Cuts and Jobs Act. Using their new tax benefits, companies such as Home Depot and FedEx are handing out employee bonuses and investing in operational expansions.
There’s more to the story than corporate tax reform, however. Owners of closely held businesses should be aware of their savings opportunities and legal obligations under the new law.
One buzzed-about aspect of the Tax Act is its impact on “pass-through” business entities. Pass through businesses are so called because their profits pass through to the business owner’s personal tax return, where the profits are taxed at the corresponding income tax rate. Most closely held businesses in the United States—including sole proprietorships, S corporations, limited liability companies, and partnerships—are pass through companies.
The new Internal Revenue Code does not change how pass through companies are taxed, but it does allow many owners to deduct 20% of their qualified business income (QBI), or taxable income minus capital gains (whichever is lesser) on their annual returns. QBI comprises any domestic income besides reasonable compensation associated with S corporations and guaranteed payments associated with partnerships and LLCs. Unlike an itemized deduction, the QBI deduction is considered an “above the line” or “between the lines” deduction, meaning it reduces overall taxable income regardless of whether an individual claims the standard deduction.
Any business is eligible for the full 20% deduction, so long as the owner’s taxable income falls below $157,500 (or $315,000 for married owners filing jointly). Note that businesses in specified service industries—such as health care, accounting, law, and professional services—cannot claim the deduction if their income exceeds $157,500 (or $315,000 for joint filers).
In light of these changes, many business owners have started to evaluate their tax burdens with renewed vigor and consider whether different business structures could present tax savings. While some, such as service-oriented companies with taxable income above the threshold, may find benefits in forming a new structure or “spinning off” an element of their business as a separate entity, owners should be aware of the various legal and financial responsibilities associated with each entity.
Keep in mind that for most businesses, taxes are a relatively minor factor in long-term growth and success. Talk to your attorney before you make a pivotal decision about your company’s future. An experienced business attorney can walk you through the pros and cons of each kind of business entity, and work with you to develop a strategy that takes all of your organization’s unique issues and circumstances—including taxes—into consideration.
If you would like to speak to an entrepreneurially minded legal advisor about tax-related issues or any business law matter, please contact me at firstname.lastname@example.org.
ABOUT MIKE MERCURIO
Mr. Mercurio is a Principal and the Chair of the Firm’s Business Law and Transactions Practice Group. He serves as outside general counsel to clients on matters related to corporate and business law, commercial transactions, government contracting, health care, construction services, and real estate. As a strategic partner to firm clients, Mr. Mercurio regularly counsels entrepreneurial individuals and assorted entities on all aspects of business and commerce including formation and structure; ownership, management and control; financing and capital; expansion and acquisition; sale and transfer; and contraction and dissolution.
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