Tax Law Headaches: Three Planning Problems for Small Businesses

For over 50 years, Bloomberg Tax’s renowned flagship daily news service, Daily Tax Report® has helped leading practitioners and policymakers stay on the cutting edge of taxation and...

By Lydia O’Neal and Allyson Versprille

Small businesses are happy with some of the 2017 tax act’s perks, but many are struggling with speed bumps—such as the complexity of the new deduction for pass-throughs—especially in the absence of guidance, tax professionals said.

Taxes were the “single most important issue” for 17 percent of small business owners during the month of May, compared to 22 percent in November, according to a survey by the National Federation of Independent Business released June 12. While that’s a one percentage point drop from the lobbying group’s April figure, it’s an increase from March, when 13 percent of small business owners named taxes as their top problem—and February, when the tally stood at 15 percent.

“I can tell you that we’re getting an unusual number of calls asking for advice,” said Anne Zimmerman, a small business CPA and a business owner in Cincinnati. “Unfortunately, we’re up to our ears in keeping up with our current clients because they all need tax planning work that they never needed before,” Zimmerman, who is co-chair of Businesses for Responsible Tax Reform, told Bloomberg Tax.

Three areas, in particular, are causing the biggest headaches for small businesses.

1. ‘Cracking and Packing’ With 199A

The 2017 tax act (Pub. L. No. 115-97) created a 20 percent deduction for pass-through businesses—those in which income flows to the owners, who are taxed as individuals. Lawmakers intended for the provision to help level the playing field between small companies and C corporations, which are taxed separately from their owners and received a 14 percentage point rate reduction in the tax overhaul.

But the deduction, under new tax code Section 199A, came with a restriction based on wages and capital for pass-through owners earning income above certain thresholds. Pass-through owners in service-related fields, including health, law, and accounting, among others, are barred from the deduction above certain income levels as well. Those limitations have left relatively small and mid-sized businesses with income above the thresholds—$157,500 for single filers and $315,000 for married taxpayers filing jointly—unsure of whether they qualify for the 20 percent write-off, absent guidance from the IRS.

“By this Friday, June 15, small business owners have to pay their second quarter” tax “estimate, or they’ll be subject to penalty,” Zimmerman said. However, they don’t know how regulations on the new pass-through deduction “are going to shake out, which makes a big difference in what they need to pay,” she said.

One of the main issues vexing taxpayers is how the IRS will treat businesses that are partially owned by the same people, she said. In response to the tax law’s pass-through provision—especially the service business limitation—some taxpayers have engaged in a method known as “cracking and packing,” Zimmerman said. Under this strategy a business owner either separates his or her business into different entities or combines multiple businesses into one to take full advantage of the new 20 percent deduction.

For example, the owner of a business that employs accountants and offers accounting services but also sells accounting supplies may want to split that business into two entities to preserve the deduction for the non-service-related income streams, Zimmerman said.

Whether or not these “cracking and packing” strategies will work depends on how the IRS writes its guidance, New York University School of Law professor David Kamin told Bloomberg Tax. Some of the strategies will likely end up working, but it’s unclear which ones those will be, he said.

2. Expensing Glitch Awaits Fix

One of the tax act’s most popular perks, including for small businesses, was the ability to immediately write off the costs of new and used property under amended Section 168(k).

But when lawmakers attempted to group three categories of property into one for new bonus depreciation rules, they assigned those property types a longer cost recovery period, rendering them ineligible for full expensing. Those hit hardest were restaurants, retailers, and businesses that had made interior renovations to their commercial property, as many had planned for a benefit they didn’t in fact receive.

More than 100 retailers, restaurant companies, and their industry groups recently wrote to leaders of the House Ways and Means and Senate Finance committees to ask them to correct the expensing provision.

Because of the drafting error, certain taxpayers can only write off 2.5 percent of their improvement costs in the year the expenditures are made and 97.5 percent over the remaining 38 years, as opposed to writing off 100 percent of the cost in the year the expenditures are made, the groups said in a June 5 letter. “This very large difference in the after-tax cost of making improvements is causing a delay in some store and restaurant remodeling projects, as well as causing some retailers to decline opportunities to purchase or lease new store locations that would require substantial improvements.”

While there aren’t a whole lot of business owners “just sitting on the sidelines” and avoiding planned investments, “there’s certainly been talk about this” among them, especially those in the retail and restaurant industries, said Troy Lewis, a manager at Lewis & Associates CPAs LLC in Draper, Utah, and associate professor of tax and accounting at Brigham Young University.

A chief concern, he said, is that the error won’t get a technical correction from Congress in the near term, he added.

“I think there’s a realistic understanding that, with the way things work in Washington, this may not be fixed for a very long time,” Lewis said. “It’s causing hesitancy and hope.”

3. Health Care Costs Slated to Rise

Likely the most universal worry for small businesses is the expected uptick in the cost of health care following the repeal of the Affordable Care Act’s individual mandate—a requirement that individuals purchase health insurance or face a tax to help subsidize the health care system, Lewis said.

“The average business owner may not understand the qualified improvement property problem,” he said, referring to the technical error in Section 168(k). “But every business owner is aware of this.”

In a November 2017 report, the Congressional Budget Office estimated that due to the repeal of the individual mandate, average premiums in the non-group, or individual, market “would increase by about 10 percent in most years of the decade (with no changes in the ages of people purchasing insurance accounted for) relative to CBO’s baseline projections.”

Caroline Bruckner, the managing director of American University’s Kogod Tax Policy Center, who worked on the Senate Committee on Small Business and Entrepreneurship from 2009 to 2014, pointed out that because the repeal doesn’t go into effect until 2019, small business owners likely haven’t “seen the effects yet.”

But over the next decade, Bruckner said, citing the CBO report, the number of insured Americans may drop by 13 million—many of which, she added, are self-employed.

“Anything that takes healthy people out of the market will cause costs to go up,” she said.

Request Daily Tax Report®