January 22/29, 2018: Volume 33, Issue 16
By Bart Basi
(First of two parts)
The passage of the Tax Cuts and Jobs Act, a.k.a the Tax Reform Bill, has a lot of flooring dealers scratching their heads. The document itself is more than 600 pages, all single spaces, and some of the words you can’t even decipher. The most important thing for retailers to consider regarding the new changes in the law is the type of business—or entity structure—under which they operate. Is the business an LLC or Subchapter S? A partnership or individual proprietorship? Or is it a “C” corporation? There are different forms of business; as such, the tax law changes depending upon how the retailer set up the business.
First off, the worst thing for a business is to not be incorporated, meaning the owner lists the business on a schedule C on his or her personal income tax return. Under this structure, all of the profits from the business will be subject to the highest personal rate applicable. Right now, that could be as high as 70%, depending on the owner’s other sources of income and how much money he’s making. Second, when he files a business on his personal income tax return as an un-incorporated company, the entire profit is subject to social security tax. So in addition to paying income tax on all of the income, the owner must pay an additional 15.3% on social security.
For those who don’t understand the nuances of this tax reform bill, it might seem, in some respects, that it could be a burden on business. The truth is it can be a benefit, but it depends on how a business is structured. For example, if a dealer is making more than $50,000 a year in profit, the best thing the owner can do is form a “C” corporation. Under this structure, the profits are taxed at a flat rate of 21%, and the social security taxes are all deducted. In this case, the owner has no personal liability.
Through the Tax Cuts and Jobs Act, the government is encouraging companies to become C corporations. As a result of the changes, all C corporations in the U.S. will pay lower taxes than any other form of business.
A new threshold
The ultimate tax benefit for retailers is not only contingent upon the specific classification but also the estimated net income. For example, if the business makes more than $50,000 (assuming, of course, the business did not report a loss for the year), the 21% tax rate is the lowest rate it can pay. That’s lower than the capital gains rate (23.8%).
If you’re a small business, and you’re making less than $50,000 in profit, the C corporation taxes have gone up 6% (it used to be 15%). Now everything is taxed at 21%. So if you’re a small company, and you’re making less than $50,000 a year profit—or if you’re showing a loss—then you want to be registered as a Subchapter S corporation. This means the losses can be deducted on the owner’s personal income tax return.
Another important point to remember: If a business is registered as a Subchapter S corporation or a partnership, and is making money, then 20% of an “income calculation” (not 20% of profits) is not subject to tax. For simplicity’s sake: If a company makes $100 of income allocable to the 20% calculation, then that means the owner will only pay taxes on $80, not $100.
Bart Basi is an attorney, a certified public accountant and the president of the Center for Financial, Legal & Tax Planning. He is and in-demand speaker and writer on financial issues impacting various businesses and industries.