In our last tax update, CWA Partner Dan Wicker discussed the tax reform law, and some of the changes both individuals and businesses can expect to see. This week, based on client questions and calls, Dan will touch on 10 other changes, as well as dive more deeply into one of the law’s most complex provisions—the 20% write-off for pass-through income.
The 20% Pass-Through Deduction
This deduction is one of the most complicated tax changes ever passed. It will take several years for the IRS to issue guidance on the deduction, but here are some key things to know if you practice as an S Corporation, partnership, LLC or sole-proprietor:
1. If you have taxable income of $315,000 or less then you will receive a 20% deduction on the flow through income from your practice. You will probably fall within this level if your practice collects $1,000,000 or less per doctor and has 60% overhead.
2. If you have taxable income of $315,000 to $415,000 you will receive some percentage of the 20% deduction, as it is phased out as taxable income reaches $415,000. You will probably fall within this level if your practice collects over $1,200,000 and less than $1,500,000 per doctor with 60% overhead.
3. If you have taxable income of $415,000 or more, you are now phased out of the deduction. You will probably fall within this level if you collect over $1,500,000 per doctor.
The levels above are general assumptions. To maximize the 20% pass-through deduction, the goal should be to lower practice net profits. Some ideas to do this are:
1. Maximize a 401(k) profit sharing plan with deductions up to $73,000 or $85,000 if over the age of 50.
2. Establish a cash balance to fund a greater percentage of practice profits toward retirement to lower personal taxable income.
3. Pay the highest reasonable rent if you own your building to create additional 20% pass-through savings on building profits.
4. Utilize and optimize depreciation and Section 179 expensing over as many years as possible that allow your practice to minimize your personal taxable income.
5. If supported, pay your children up to $12,000 annually from the practice based on the new higher standard deduction of $12,000 per individual.
6. Consider the potential for carving out income and related expenses related to the former Section 199 deduction for such as manufacturing of retainers or milling of crowns with a Cerec to qualify for additional pass-through deductions.
Ten Additional Important Tax Changes to Note:
1. C Corporations. The Corporate tax rate has been slashed from 35% to 21% and is applicable to dentists. Many doctors that operate as a C Corp have loans to shareholders from previous years. Doctors with carryover losses from previous years should take full advantage of the carryover losses and payback the shareholder loan with no tax. Those with no carryover losses, but who have a corporation with a loan to a shareholder, should evaluate the ability to pay back the shareholder loan and utilize a potential lower tax rate of 21%.
2. Section 179 Expensing. Qualified leasehold improvements including roofs, HVAC, alarm and security systems qualify for the Section 179 expense. Optimizing these assets over equipment purchases for 179 expensing will provide the optimal depreciation deduction.
3. Luxury Auto & SUV Depreciation. The depreciation limits for luxury passenger cars under 6,000 pounds has been increased and the SUV deduction for over 6,000 pounds can now be expensed at 100% due to bonus depreciation.
4. Meals & Entertainment. Doctors need to budget wisely on entertainment such as sporting tickets, golf fees and any dues to a club, as these are now non-deductible as entertainment. Meals for travel and for the convenience of the employer for the staff are still 50% deductible.
5. Domestic Production Activities. The deduction related to production activities that many orthodontists and general dentists utilizing a Cerec is now repealed beginning January 1, 2018.
6. Individual Tax Rates. The new tax brackets start at higher levels and the new rates are 2% to 4% lower than 2017 rates. Doctors should review the federal withholding and estimated tax payments for 2018 and adjust down to increase current cash flow.
7. Home Equity Debt. Home equity interest is no longer deductible. Doctor’s should look for ways to eliminate home equity indebtedness and minimize non-deductible debt.
8. Itemized Deductions. The state, local and property tax deductions are limited to $10,000. This is more than likely a loss of deduction for most doctors. New home mortgage debt is limited to $750,000 down from $1,000,000. The phase out limitation on itemized deductions is eliminated so many doctors will see an increase in overall itemized deductions if they don’t live in a high state income tax. This will allow a further reduction of personal income taxes.
9. Alternative Minimum Tax. The AMT is left intact, but the exemption limit is raised. Since the addback for state and local taxes is now limited, the AMT will affect fewer doctors. This should help many doctors living in high state income tax states that were previously paying AMT.
10. Estate & Gift Tax. Doctors need to evaluate their overall estate plan in regard to the new higher limits of $11.2 million per spouse.
The information featured in this blog is not intended to be personal tax advice. If you are a dentist, it is now more important than ever to seek a CPA that specializes in your industry. Ensure your CPA is evaluating how the new corporate pass-through deduction, or the corporate tax rate of 21% should be implemented within your financial planning today. Effectively incorporating the tax changes into your plan can make a major impact on your 2018 and future financial growth.
Cain Watters & Associates