Everyone from the typical American taxpayer to the business owner is dealing with the ramifications of President Donald Trump’s new tax code, the Tax Cuts and Jobs Act (TCJA), because the new simplified IRS code remains labyrinthine. This legislation presents a mixed bag of benefits and disadvantages for owners of pharmacy businesses, introducing an array of new deductions and tax credits that owners may make use of.
The Tax Entity Landscape
The TCJA consists of new deductions and credits that will affect each small business differently. This summary intends to provide an overview to help pharmacy business owners broadly comprehend the immediate consequences of the new tax plan. Every business owner knows that the devil is in the details.
The TCJA will have different effects on different business entities.
4 Possible Types of Business Entities
1) The C corporation (C corp) is treated by law as an entity separate from its owners. A C corp, like an individual, may make a profit, be held to legal liability and pay its own taxes, as well as create individual tax liability if disbursements are made to its shareholders.
2) The S corporation (S corp) avoids the two levels of taxation inherent to a C corp and takes advantage of pass-through taxation. This allows the business owner to report taxable income on an individual tax return and thus be spared being taxed twice, as in the case of the C corp.
3) The limited liability company (LLC) typically consists of one or more members as the owners who do not bear personal liability for the LLC’s debt and who are taxed at the level of the business owners in manner similar to that of the S corp.
4) The sole proprietorship is legally indistinguishable from its owner, and income and losses are taxed at the level of the individual owner’s personal income tax return.
Different Cuts for Different Corps
President Trump’s tax plan introduces a flat rate of 21 percent for C corps, attening the previous range of 15 percent to 35 percent. However, the vast majority of small businesses are not operating as C corps. The flat rate is going to affect the largest corporations in the United States. Yet at the same time, the TCJA repealed the corporate alternative minimum tax, which was created to prevent large corporations from claiming excessive deductions to lower their tax liability.
This flat rate does not apply to an S corp, in which profits and losses pass through to the business owners and are then reported as personal income. The tax liability of the business owner and the business are closely related. The most important benefit for a small business (LLC, S corp, partnership or sole proprietorship) is being able to file as a pass-through entity, which may be entitled to a 20 percent business income deduction if it meets certain income criteria. In other words, a pass-through entity can knock 20 percent off earnings before paying taxes on the sum, provided that certain criteria are met. For example, if the pass-through business sources its revenue through a provider of professional services (doctor, dentist, lawyer, architect, etc.), it is then ineligible for this deduction.
Queen-Size Write-Offs for King-Size Expenses
An important new aspect of the TCJA permits small businesses to write off the lion’s share of significant investments in equipment immediately instead of depreciating these investments over the long term, which is known as bonus depreciation. The deduction limits have also been raised to permit businesses to buy new equipment. For example, a business can take a larger expense write-off for buying a car for business use.
President Trump’s tax plan notably includes all equipment that is still in use. Business owners can now deduct up to $1 million in equipment investments. This can make a huge difference for a small business because it can deduct 100 percent of the cost of a new piece of equipment the year it is purchased, versus only 50 percent under the previous regulations. Furthermore, the permissible categories of deduction have been enlarged to include a laptop as well as the facility that houses it. The ceilings on Section 179 deductions, which regulate depreciation to building improvements ( fire alarms, security, etc.), have also been raised.
Cash Versus Accrual Methods of Accounting
The TCJA and the previous tax laws permit certain size companies to select the cash method of accounting instead of the accrual method. The cash method records revenue immediately as it is received from customers and records expenses as soon as they are paid out. Chronology is the heart of the matter: Under the accrual method, businesses must wait until they sell inventory before deducting its cost, as opposed to deducting it immediately when they make the purchase. The new tax plan resets the annual revenue threshold from $5 million to $25 million, which spectacularly increases the number of businesses eligible for such exemptions.
Disadvantages of the TCJA
Despite the increased deductions and innovative credits discussed above, some advantages that small business owners once enjoyed are no longer available. Some of these are compensatory for the lower tax rate instituted for C corps. The business interest deduction for business owners who took out a small business loan has been drastically reduced to 30 percent of earnings before interest, tax, depreciation and amortization of the business; however, if the small business has average gross revenues of $25 million or less, it is exempt from this rule.
The Section 199 deduction was intended to give manufacturers an incentive to produce goods domestically in the United States. It permitted manufacturers to take a 9 percent deduction on income generated from eligible production activities. However, in practice, it was a loophole because a company was permitted to assemble already-manufactured items (for example, hand tools manufactured outside the United States) into an assorted toolkit, for which they could then claim a deduction.
Before the TCJA, business owners were entitled to deduct up to 50 percent of entertainment expenses related to their business. The TCJA does not permit any deductions for entertainment expenses. Also, before the TCJA, meals for employees and staff were 100 percent deductible, but that deduction has now been reduced to 50 percent. This deduction will be phased out entirely by 2025.
The new tax plan no longer allows deductions for employee transportation, which includes expenses related to employee parking as well as reimbursement for the use of public transportation, car pools and bicycle commutes.
Talk to Your Tax Attorney or Accountant
The best thing a small business owner can do is discuss the new tax code with a tax attorney or their accountant to determine its impact, since each business has its own set of unique facts and circumstances. Although difficult to generalize, assessing new credits and deductions that a small business owner may take advantage of is possible. Some provisions in the new tax code are permanent, while others are transient and will be phased out by 2025. The pharmacy business owner must determine whether its business is advantageously structured. Is an LLC better than an S corp?
Bottom line: Make sure that business records are well kept and that a business purpose can be demonstrated for each expense. The intent of President Trump’s new tax code is to stimulate businesses to invest in their workers and enable growth!