The Tax Cuts and Jobs Act (The Act) was signed into law on December 22nd and brings with it the most sweeping changes to the Tax Code in more than 30 years. In some cases professional service organizations may be one of the few industries that is a loser in the context of overall tax reform. While the top marginal rates are lower and C corporations are now eligible for the reduced flat rate of 21%, pass-through entities or sole proprietorships that have income above a certain threshold will not be eligible for the pass-through deduction. The summary below illustrates this and a few other key changes that will impact taxpayers in this industry.
- Reduced corporate tax rate of 21% applies to all C corporations. The flat 35% tax rate that previously applied to Professional Service Corporations (PSC’s) has been removed.
- The 20 % deduction for pass-through entities does not apply to specified service businesses in the areas such as health, law, accounting, actuarial science, performing arts, athletics, financial services, brokerage services, consulting or any business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners. The law specifically excludes architecture and engineering from the specified service definition. If your business falls within one of these specified service areas you are eligible for this deduction for income up to $315,000 Joint filers ($157,500 individuals) and it is completely phased out at $415,000. We expect further guidance regarding the definitions of what activities fall within the above specified service categories. Stay tuned.
- The Act provides a limitation on the deductibility of business interest expense. This limitation is based on 30% of taxable Earnings Before Interest, Depreciation, Taxes and Amortization (EBITDA) for tax years 2018 to 2021. The limitation is then based on 30% of Earnings Before Interest and Taxes (EBIT) for tax years beginning after 2021. Businesses with average annual gross receipts of less than $25 million are not subject to this limitation. The limitation is determined at the entity level.
- Entertainment expenses under the Act are now 100% non-deductible. This will have a significant impact on cost of client entertainment. Previously these expenses were subject to a 50% limitation. Food and beverages are still subject to a 50% deduction limitation assuming they are directly connected to a trade or business. The Act also eliminates the deduction for meals provided for the convenience of the employer that is currently 100% deductible, but applies to amounts paid or incurred after December 31, 2025.
- The Act disallows excess business losses for taxpayers other than C corporations beginning with the 2018 tax year and ending with the 2025 tax year. An excess business loss is determined at the individual taxpayer level and aggregates pass-through and sole proprietorship losses that exceed $500,000 for joint filers ($250,000 for all other taxpayers) in any tax year. The amount of losses in excess of $500,000 will carry forward to future tax years as a Net Operating Loss (NOL).
- Certain fringe benefits are now no longer deductible unless they are included in the respective employee’s compensation.
Please contact any member of Schneider Downs Tax Department for additional information regarding these specific tax law changes and any other changes that were included in the Tax Cuts and Jobs Act.