Agents and brokers are keeping a close eye on the tax reform plan, signed into law by President Donald Trump in December, which is expected to encourage economic growth by adjusting how small and mid-sized businesses and corporations are taxed.
The reforms are expected to bring tax cuts to many American companies.
“I think we’ll see a lot of companies investing in higher salaries and benefits, because in such a tight labor market they’re all struggling with how to attract talent, and when that’s happening it’s big pressure on salary and benefits,” said Rob Fowler, president and CEO of the Small Business Association of Michigan.
For many agents and brokers, deciphering the benefits for small- and mid-sized businesses can be, well, taxing. The benefits are complex.
Instead of lowering the rate on all pass-through companies, the new law allows pass-throughs to deduct up to 20 percent of their income based on what type of company they are.
“I could see some companies examining whether or not they are organized the best way,” Fowler said. “A lot of people organized their company the way they did because of the federal tax law.”
The vast majority of businesses in the U.S. — 95 percent of them in 2014, according to the Treasury Department — are so-called “pass-through companies” whose profits are taxed according to the owner’s personal rate. Companies organized as sole proprietorships, LLCs and partnerships are all pass-through companies.
Under the new tax plan, those businesses can deduct 20 percent of pass-through income. That means the IRS will only tax 80 percent of a business owner’s personal income.
Personal service companies, such as real estate agents, attorneys, accountants, brokers and doctors, have a different set of rules.
The 20 percent deduction is only available for single taxpayers with income up to $157,500 or married couples filing jointly with incomes up to $315,000. Sole proprietorships, for instance, would not qualify once the income threshold is exceeded.
Kurt Piwko, partner, Plante Moran PLLC, said that once the income exceeds the threshold, companies need W-2 wages or assets.
“Congress made the decision to tie taxes to W-2 wages paid to incentivize businesses to make investments in people or capital,” Piwko said. “If a business makes a lot of money but has no employees and no depreciable assets, in the view of Congress, they do not deserve a tax benefit because they are not viewed as driving economic growth.”
According to Piwko, companies should note that the definition of professional services doesn’t necessary include all personal service-type activities.
“A law firm or accounting firm would clearly be disqualified, but a sole proprietor running a delivery business would still be OK,” he said.
The new tax reform law allows companies to take an immediate first-year deduction on property new to the taxpayer. This could benefit brokers who have invested in new property.
One new item is the elimination of the entertainment deduction, which could change some aspects of business.
Agents and brokers who are accustomed to taking clients golfing will have to take them out for a meal instead, as entertainment can no longer be deducted.
The way the law is organized may tempt many brokerages to change their entity structure.
While the new law will lower the corporate tax rate from 35 percent to 21 percent, there is a common misconception for pass-through entity owners is that they should become a C corporation.
The change in taxation could be a favorable situation for many brokerages, but it may not make sense for many companies to change their business structure. C Corporations will not necessarily receive a lower tax rate.
On the business side, agents may find that wealthier clients are more likely to take advantage of key tax breaks that are set to be downsized, including the mortgage interest deduction and the state and local tax, or SALT, deduction.
Three policy changes in the bill are worth noting for homeowners: the mortgage interest deduction cap will fall, the standard deduction will increase, and the state and local tax deduction has been restricted.
Ultimately, brokers should talk to their accountant, consider the impact of the new law on their business and then make informed decisions on how to proceed.