The federal tax reform Congress enacted at the end of 2017 comes with significant complexity that tax professionals say they’re still sorting through as the 2019 tax season begins.
For the first time, tax advisers are beginning to prepare and file returns for clients under the 2017 Tax Cuts and Jobs Act. Given the depth of the changes and the complexity of the new federal tax code, the only certainty for the 2019 tax season is the expectation that business owners will need to spend more time with their CPAs and tax advisers as they dive into the details and work through their returns.
“In prior years, we knew what to expect. This year, we need to expect the unexpected because there’s so much in the new law we can’t really anticipate how it’s going to play out,” said Aaron VanSoest, a tax partner at the Grand Rapids office of accounting and consulting firm Crowe LLP.
“There are a lot of unanswered questions out there that tax professionals, quite frankly, just don’t have the answers to at this point,” VanSoest said. “I’ve been asking my clients to be patient this year. This may not move to completion as quickly because it makes sense to spend a few minutes and step back and think about where we’re at with respect to the new law.”
The Internal Revenue Service has not yet finalized or issued, in some cases, many of the rules and guidance needed to implement the tax reform law, according VanSoest and other tax professionals. That creates even more uncertainty for this year’s returns and the net effect of tax reform on individual businesses.
Among them are IRS rules proposed in December for interest expense deductions, and rules proposed in November for bonus expense deductions.
VanSoest has been telling clients that as April 15 approaches, they may have to consider filing for an extension on their 2019 returns and await further guidance from the IRS. Or they can go ahead and file on time “based upon what guidance is out and take a position based on what we think the likely outcome is,” VanSoest said.
“In the past, for an experienced practitioner, you could look at a situation and have a pretty good idea how it’s going to shake out,” he said. “Now there’s just a lot of uncertainty because a lot of the rules are yet to be fully defined. There’s a lot of uncertainty on how things are going to play out.”
Ryan Riehl, a tax attorney and senior principal at Miller, Canfield, Paddock and Stone PLC in Troy, expects the IRS could take two years or more to issue and finalize all of the rules and regulations needed to fully implement the tax law.
The Tax Cuts and Jobs Act was “definitely the most significant piece of tax legislation” in more than 30 years, Riehl said.
“Naturally, it’s going to take a few years to sort through what these rules are. The IRS has limited resources so it can only get guidance out so quickly,” he said. “Certain things were somewhat well defined (in the law), and other things are still sort of being worked through. We’re slowly getting there.”
The biggest change Congress made in the federal tax reform law was to reduce the tax rate to 21 percent from 35 percent for businesses classified as C corps. The flat rate replaced a graduated scale of 15 percent to 35 percent for corporations.
The law also changed some accounting methods “that can result in very significant benefits” for small businesses, said Dan Lynn, a tax partner at Beene Garter LLP in Grand Rapids.
Among them is the ability to write off 100 percent of fixed assets a company acquires through new and used equipment purchases in the first year, he said. As well, the law eliminated many corporate deductions.
The net effect of tax reform “has been a mixed bag,” although a majority of Beene Garter’s clients should see an overall reduction in their federal tax liability, Lynn said.
“If you take the time to work through things, there definitely is going to be a payoff in just making sure you’re taking the most advantageous positions and that you are making the best choices because there are a lot of goodies here,” Lynn said. “There’s a lot of stuff that’s really going to help companies out.”
Another significant change in the federal tax code was the creation of a new deduction for so-called “pass-through” entities whose owners pay taxes on their personal income from the business. Rules for the pass-through deduction, proposed in August, also remain unfinalized.
Under the prior federal tax code, income for S corps and limited liability companies (LLC) that passed through to the owner got taxed at individual rates that topped out at 39.6 percent. Through the new law, which lowered the top individual tax rate to 37 percent, pass-through business entities can get a 20-percent deduction on qualified business income. The deduction, unless renewed by Congress, expires Dec. 31, 2025.
“This is where a lot of folks are going to see some benefit,” Riehl said.
To qualify for the full deduction, an S corp business owner’s taxable income must stay below $157,500 if they are single, or $315,000 if married. The law placed limits on the deduction for income that exceeds those thresholds.
A year ago, right after the law passed, the primary question for many business owners was whether to change their classification to a C corp to take advantage of the 21-percent corporate tax rate.
Although few opted to convert their classification in 2018, the reduced rate in the tax reform law made becoming a C corp “at least a more viable business alternative for some taxpayers now,” Riehl said.
The bigger question now is whether more startup companies will organize as C corps, although Riehl generally advises clients to form as an S corp or LLC.
“It could work in certain circumstances,” he said.
At Crowe, VanSoest had “quite a few” clients that went through an in-depth analysis of the question. He expects more to consider whether to change classification after going through the first tax returns under the new law.
“I definitely had some clients where we did an analysis last year and they said, ‘Yeah, we see that. We want to digest it. We want to see some of the rules that are coming out.’ Some of them wanted to see what the outcome of the election last fall was going to be,” VanSoest said. “They are going to be looking at it again and keep it on their radar for a bit in the future.”
A key consideration when considering a change is the national political climate and how it could shift. Once a company revokes an S corp classification and elects to become a C corp, it cannot go back for five years.
Democrats now control the U.S. House following the 2018 midterm elections. If they were to win the Senate and take the White House in 2020, more change in the federal tax code could come, including a higher corporate tax rate, VanSoest said.
“Then all of a sudden being a C corp doesn’t make sense anymore,” he said.