The annual tax planning process typically begins each fall. From a tax accountant’s work flow perspective, business and personal tax returns for clients who filed for extensions have been completed. Staff have had some time to recover from the pressures connected with the wrap-up of the tax busy season. Fall is the time to start the process all over again.
The tax planning process can be the most critical component of the annual relationship cycle between a business owner and their CPA. Oversights in the planning process may not be fixable when tax returns are ultimately prepared after the tax year has closed.
Last year’s planning process involved a great deal of uncertainty, as differences between the House and Senate tax reform proposals were not resolved until the Tax Cuts and Jobs Act was passed in December. One may anticipate a much lower level of uncertainty for the 2018 planning cycle. While there are ongoing legislative initiatives under consideration for a second phase of tax reform, nothing resembles the magnitude of changes enacted at the end of 2017.
Uncertainty for the 2018 planning cycle will, in many respects, involve a common concern: we have new tax provisions, but the statute itself still requires further guidance in important respects. The IRS is still in the process of developing interpretive regulations, which may have important implications for planning decisions.
The 600-pound gorilla for many business owners involves the question of whether to remain a pass-through entity or convert to a C corporation. Even if the new 20 percent deduction will be available for qualified business income flowing from pass-through entities, perhaps resulting in a top marginal Federal effective tax rate of 29.6 percent, a C corporation tax rate of 21 percent may seem more appealing. However, life after switching to a C corporation can present a new set of tax tensions. You’ll need to address the owners’ personal cash flow requirements as well as a possible future sale of the business, while avoiding significantly higher Federal tax at the combined business and personal levels.
For many business owners, concerns about potential tax rate changes that could result from a shift in the political landscape after the November election have led to a “wait and see” approach. They want to hold off on making any dramatic changes to their tax structure too quickly. But you can still examine other opportunities that may be available besides a change from a pass-through to a C corporation taxable entity. For example, determining how to optimize the potential benefit of the 20 percent qualified business income deduction will be a significant discussion item for the 2018 planning cycle.
In many cases, the challenge at hand will involve maximizing what is an overall positive outcome; i.e., many business owners should anticipate seeing their Federal tax bill go down. The planning process will focus on the magnitude of the reduction; certainly, this is a better issue to deal with than a tax bill that is climbing. But careful analysis is needed, because some decisions may yield short-term tax savings at the potential cost of a disproportionate tax increase in the future.
The general principals of tax planning involve two fundamental components:
- A permanent tax savings is the optimal result.
- Managing the timing of tax payments to achieve the greatest possible long-term benefit. In other words, if I must pay tax, I would prefer to pay it in the future so long as the ultimate amount I pay does not go up disproportionate to the time value of the economic benefit of delaying the payment.
The new provisions allowing for a full write-off of qualified equipment and other fixed assets outlays are very appealing. However, particularly where the related debt will need to be repaid over time, a higher tax bill in the future can present cash flow concerns. A tax write-off at an effective Federal rate of 29.6 percent – where the 20 percent qualified business income deduction is currently available – may not turn out to be as appealing if loan repayments need to be made in a future year when the effective Federal tax rate has returned to a historical level of 39.6 percent or something similar.
With all that said, we recommend beginning your 2018 tax planning process earlier than in years past. We welcome the opportunity to meet with you as IRS pronouncements come out, to evaluate the opportunities and challenges they may present.
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