When the Tax Cuts and Jobs Act passed in 2017, the massive reform of the U.S. tax code made significant changes to corporate income taxes, as well as taxes on pass-through entities like sole proprietorships, partnerships and S-corporations.
In terms of individual income taxes, the TCJA simplified the U.S. tax code by nearly doubling the standard deduction, thus increasing the number of individuals who utilize the standard deduction and eliminating the need for many households to itemize their yearly tax deductions.
But for businesses — particularly pass-through entities in Colorado Springs, where there is a high concentration of S-corporations — the annual to-do of filing year-end taxes has become considerably more complex.
With that in mind, local accounting firms say it is more important than ever for business owners who are not intimately familiar with the inner workings of the new tax code to meet with their tax preparers before the clock strikes midnight to end 2019.
While this year didn’t layer any more sweeping changes on top of the TCJA, the complexities of the new code mean business owners will likely need to reevaluate their filing statuses and deductions more frequently than ever.
“I started practicing [as a CPA] in 1985, and for 30 years the law pretty much stayed the law,” said Judy Kaltenbacher, tax partner in charge at Springs-based accounting firm Stockman Kast Ryan + Co.
“So that’s what is so different for somebody like me that has done this for so long, is that it didn’t really change for all those years. With the old law, you pretty much made your choices and nothing would necessarily impact that choice in a year-over-year analysis.
“But now, all of a sudden, people need to think about: Should I be a C-corporation because I can get this 21 percent rate? Or is it better for me to stay as an S-corporation? People are still asking themselves that question, especially this year, because they’ve been through a year of the law.”
LOOKING BACK AT TCJA
The massive, sweeping changes that came about as a result of the TCJA’s passage went into effect in 2018, the most significant of which, in terms of its impact on corporations, was the lowering of the corporate tax rate from 35 to 21 percent.
But for pass-through entities — which are not subject to corporate income tax because business owners include their share of profits as taxable income under the individual income tax — the primary benefit of the TCJA comes through the qualified business income deduction, which allows a qualified business to take 20 percent of its net income and deduct it on individual income tax returns.
Prior to the TCJA, all pass-through business income was subject to personal income tax.
“What they tried to do with this deduction was to get the tax rate equalized between C-corporations and pass-through entities,” Kaltenbacher explained. “So C-corps got this 21 percent deduction, but S-corps didn’t because their income flows through down to the individuals, and the individuals didn’t get as big of a drop in the rates. So they tried to get these businesses a deduction that would help equalize the rate as though this pass-through entity were a C-corp and taking advantage of that 21 percent rate.”
Fortunately for business owners, when it comes to filing this year’s taxes, the major changes implemented by the TCJA all went into effect in 2018 — and outside of a few inflationary adjustments, there were virtually no significant changes in 2019.
“Sometimes no news is good news,” said Jason Watson, the managing partner at WCG Inc. “There’s always little tiny nuances and changes that affect a small segment of the business community. So I don’t want to say that nothing has changed … but in terms of major business changes, there really aren’t any.”
That said, a business’ income and expenditures will often fluctuate from year to year, and those factors can have a range of impacts on tax filings — such as when changes income may land a pass-through entity owner in a higher or lower tax bracket. That means it’s more important than ever for business owners to meet with their tax preparers before Dec. 31 to determine whether their business classification or current deductions need adjusting.
To picture the types of individualized decisions business owners must make in relation to their 2019 filings, visualize a massive, multi-layered flowchart with dozens of starting points representing new components of the tax code, each of which filters down through layer after layer of qualifying prompts until reaching a specific outcome at the bottom of the chart.
Take the qualified business income deduction, for example.
In a flowchart that Stockman Kast Ryan + Co. makes available to its clients, the first prompt asks: “Are you a sole proprietor, [S-corporation,] in trusts and estates, or in a partnership?”
If the answer is “Yes,” you may be eligible; if it’s “No,” you do not qualify.
For those who answered, “Yes,” the next prompt on the chart would be: “Is your taxable income more or less than $321,400 if married filing jointly or $167,700 or $167,725 for other filers?” If the answer is “Less,” you are eligible; if it’s “More,” you would move onto the next prompt. And on and on it goes.
Just because a business owner qualifies at the first prompt, enabling them to move to the next layer down on the chart, doesn’t necessarily mean they will qualify for the QBI deduction.
Now consider that the QBI chart is just one small component in all of the new changes to the tax code following the TCJA, and it gives a picture of how filings will largely differ from one business to another — even those with similar classifications and business types.
“It’s a very specific, individualized analysis for every business owner,” Kaltenbacher said, “and that’s why it’s so important for them to visit with their tax professional to determine the answers to these questions.”