Now this advice can relate to many things. But this is a tax column, and every now and then I try to do what I am supposed to do. Since this column is only once a week I am thankful that I don’t have to make a habit out of it.
The focus of my advice is making changes based on the new tax law. In particular, changing the way in which the business is organized. Right now this is a hot topic for advice givers. Advice seekers need to cool off before acting on this advice.
Why am I being a wet blanket? Primarily because we don’t have all the information we need to make a decision to drastically change the form of doing business. Regulations expected to be issued later this summer or fall will help with the decision-making process.
The corporate form tends to be the one making waves among tax practitioners. This includes the regular, or “C” corporation, and the more commonly used “S” corporation.
The C corporation has fallen out of favor because it carries two levels of tax – one when profits are earned by the entity and another when distributed in a way that is not tax-deductible to the corporation.
The new law shakes things up by making the lowest tax rate apply to the corporate-level earnings. Dividend payments, which are the culprit for the second level of tax, are still taxed at rates applicable to capital gains.
I do believe that tax practitioners need to consider the C corporation in many situations where they were written off just one year ago. But the two levels of tax is still difficult for many clients to swallow.
And the recommendation to use a C corporation is premised on what may be shaky ground – that is, that a future Congress will not change the law.
There are two reasons why the law might change. First, the political affiliations of the House and Senate may flip, perhaps even in November. Democrats don’t appreciate being left out of the process in the 2017 legislation.
Second, the budget deficit is exploding. President Ronald Reagan’s 1981 tax cuts were followed by tax increases in 1982 and 1984 to attempt to reign in the growing deficits.
S corporations, which have only one level of tax, are the darlings of larger business deduction under the new law.
Many tax practitioners are now recommending S corporations because they offer the ability to pay the shareholder wages for employment. These wages may help to create a larger business deduction under the new law.
But in most cases, the wages won’t affect the business deduction. Wages only matter for high-income taxpayers subject to a deduction limitation. The need for an S corporation then becomes a more subtle decision when the right factors are considered.
Changing to the S corporation form may prove costly if the owner later wants to receive property distributions. The S corporation may then accelerate gains attributable to the property.
Not mentioned yet is what is presently the most common business entity type used in New Mexico – the partnership. The new law creates several reasons to not be a partnership, but none that suggest that the partnership form continues to be the best option.
But even with the new law set aside, partnerships may well continue to be the best choice. The problem is that corporations, under the new law, are now the latest shiny rock.
The new law may offer partnerships little of new interest in the entity-choice game (partnerships allow the new qualified business income deduction, but so do proprietorships and S corporations, so there is nothing special to the partnership form in the new law).
And yet partnerships still offer the greatest tax flexibility to creative tax planners. Something old may beat something new, and the new corporate rate may be something borrowed, making the taxpayer blue when that rate is changed.
So relax, you don’t need to change anything. Yet. Let’s at least wait until Treasury issues new regulations defining some of the business deduction rules.
Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at firstname.lastname@example.org.