Written by: Eleanor C. Werenko
Tax Cuts for Corporations and Pass-Through Entities. With the passage of the Tax Cuts and Jobs Act on December 22, 2017, U.S. companies will see sweeping changes in business taxation, with the corporate tax rate going from 35% to 21%, and a 20% deduction for taxpayers who have domestic “qualified business income” from a pass-through entity or sole proprietorship.” There is a lot to unpack here and while we won’t know what the final impacts will be until the IRS issues regulations later in the year, it is clear that if your business is structured as a corporation you will enjoy a tax rate of 21% on the C-Corporation’s taxable income with no sunset on the provision. The impacts on pass-through entities and sole-proprietorships, however, are much less straight forward and will sunset December 31, 2025. If your business is a pass-through entity, meaning a limited liability company, partnership, limited partnership, sole proprietorship, or corporation or limited liability company taxed as an S-Corporation, you will want to become familiar with the Act and its implications on your personal tax return and on the sustainability of your company in an increasingly competitive environment.
While some pass-through entities owners can expect to see a comparably higher net income after taxes than corporate shareholders, others may want to consider conversion to a C-Corporation to take advantage of lower tax rates, and the stability afforded C-Corporations under the Act. So which lucky pass-through owners are among those that will see a comparably higher net income than corporate shareholders? The general rule is that the 20% deduction applies to all qualified business income (QBI) (domestic income other than investment income such as dividends and interest). There are however, exceptions and if the exceptions apply to your business, the 20% deduction is severely reduced or eliminated. Among the business to which the exceptions apply are specified services businesses (SBB). SBB’s include:
As an owner of an SBB, if your individual income, or married filing jointly income, is less than $157,500 or $315,000 respectively, the deduction is potentially allowed. If, however, your individual or married filing jointly income is more than $157,500/$315,000 you may want to take a closer look at the impacts of the Act on your taxes and whether or not a conversion may be beneficial.
Even if your pass-through business is not an SBB you will still want to understand how the deduction applies and what limitations may exist. Until the IRS promulgates regulations providing further guidance on how the Act will be implemented, it is probably premature to make any decisions with respect to conversion, or otherwise, but in the next few months pass-through entities may want to work closely with a CPA and attorney to determine the appropriate entity choice in the new tax era.
Tax Credit for Employers Offering Paid Family Medical Leave. Also impacting employers is a federal tax credit for employers that provide paid family and medical leave to their employees. In order to qualify for the credit, an employer must allow all-qualifying, full-time employees, at least two weeks of paid family and medical leave annually, and must pay a qualifying employee at least 50% of their normal wages. Under the Act a qualifying employee is one who has been employed for at least one year, and who for the preceding year, had compensation not in excess of 60% of the compensation threshold for highly compensated employees ($120,000 in 2018).
The tax credit which is equal to 12.5% of the wages paid to an employee while on leave, plus 0.25% for each percentage point in excess of 50% (for a total possible credit of 25% of wages paid) applies only to “family and medical leave” as defined under Section 102(a)(1)(a)-(e) or 102(a)(3) of the Family and Medical Leave Act (FMLA). Family and medical leave does not include vacation leave, personal leave or medical or sick leave that does not qualify under FMLA.
This provision may be behind Walmart’s recent decision to increase paid maternity leave from 6-8 weeks for full time employees at half-time pay to 10 weeks at full-time pay. This is not entirely clear, however, because in order to qualify for the exemption the paid leave must be made available to all qualifying employees and it appears that Walmart’s policy may only apply to mothers on maternity leave and not all qualifying employees who may need to take family and medical leave for a non-maternity reason. In order to qualify for the credit, Walmart’s policy would have to be available to all qualifying employees in need of family and medical leave. If the tax credit were available and a qualifying full-time Walmart employee, making Walmart’s newly announced $11.00/hour minimum wage, took 10 weeks of family and medical leave Walmart would enjoy a tax credit of $1,100 ($11/hr x 40hrs/week x 10 weeks x 25%) to offset the $4400 in wages (before deductions) paid to the employee.
 Full text of the Tax Cuts and Jobs Act is available at https://www.congress.gov/bill/115th-congress/house-bill/1/text