The new tax legislation set to become law when signed by President Trump is being hailed as the biggest tax reform since 1986. But what does it mean exactly for custom integration businesses?
Obviously, consult your tax attorney, but whether you are a Democrat or Republican or neither (like me), what can we glean from the 440-page bill from the perspective your own tax liability. (We are not addressing what the potential tax reform might mean for your clients. Will reducing the tax burden on your affluent clients mean they will spend more money with you? Let’s hope so.)
First, let’s do a quick refresher on the economic profile of an average CE pro. Most are small companies. The average firm has eight employees and median company revenues of around $1 million, according to the upcoming CE Pro 2018 State of the Industry Study that will appear in the January issue of CE Pro.
Most owners of integration companies, about 78 percent, pay themselves a salary. Breaking that data down further, 48 percent of integrators take a salary, plus the company profits, for their income. Another 30 percent do not pay themselves the company profits, but just take a straight salary. The remaining 22 percent of integrators do not take a salary, but instead pay themselves only from the company profits.
Meanwhile, the industry has been “profit starved” for quite a while. The typical custom integration company had just over 4 percent profit in 2015 (the latest data available). That means a $1 million revenue integration company put only $41,000 to the bottom line at the end of the year. If the owner pays himself or herself a salary, the average salary equated to just over 15 percent of company revenues, or about $155,000.
Finally, from a business tax structure, 30 percent of custom integration companies are Limited Liability Corporations (LLCs). Another 28 percent are Sole Proprietorships, another 28 percent are S-Corporations, and 3 percent are partnerships.
That backdrop information is important to understand because the new tax law (when it is signed). Now, let’s take a look.
‘Pass-Through’ Income
The tax reform includes potential tax breaks for small businesses, especially S-Corps, sometimes labeled as a “pass-through” entity. In an S-Corp, a business owner can “pass-through” his business income through his or her personal taxes, and therefore pay the personal tax rate on his or her own business income, including the company profits. The new law calls for this tax rate to be reduced from 39.6 percent to 25 percent. The deal will allow CE pros to deduct 20 percent of their business income up to $157,500 for single filers, $315,000 for joint filers. After those dollar amounts are reached, the rate declines.
Equipment Deduction
Another change is the equipment deduction. Companies will be able to deduct a larger portion of their equipment purchases, and write off those purchases upfront versus depreciate them over five years. According to the Associated Press, the Section 179 deduction will also allow companies to deduct $1 million in equipment purchases, up from the current level of $510,000. That means integrators can use the deduction buy computers, office chairs, vehicles and tools.
Real Estate Deduction
There is also a provision for real estate purchases for the business. Currently, like equipment property must be depreciated over a period ranging from 2.5 years to decades, depending on what kind of property it is. The agreement generally allows for full up-front deductions of purchases each year for the next five years, subject to limitations on some purchases, according to the AP.
Cash Method of Accounting
According to the AP, the law will allow some larger custom integration companies to use the cash method of accounting rather than the more complex accrual method. Under cash accounting, a company records income when it's received and expenses when they're paid, says the AP. Under accrual accounting, income and expenses are booked when they are owed rather than when they're received or paid. Businesses that carry inventory, like some integrators, previously were required by law to use the accrual method. But the new tax code will exempt any business under $25 million in annual revenue. Previously, any company over $5 million in revenue had to use the accrual method.
Business Interest Deductions
The agreement does not change business interest deductions. Integrators will be limited to deducting business interest expenses at 30 percent of their taxable income. If you are a landlord, you will still be able to fully deduct mortgage interest.
State, Local, Property Tax
The new law will cap the amount of deduction for state, local and property tax at $10,000.
Alternative Minimum Tax
The AMT sometimes comes into play for CE pros who might have a huge multi-million project over one or two years, then see a drastic reduction income the following years after that project is over. The AMT remains for business owners, but it is abolished for corporations. Individual income up to $70,300 will be exempt from the AMT, compared to the current level of $54,300. The exemption begins to decline when a taxpayer's income reaches $500,000, says the AP.
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