Payroll departments are scrambling to adjust while pundits continue debating the pros and cons behind the $1.5 trillion Tax Reform Act signed into law by President Donald Trump on December 22.
“Some of the new provisions are anything but simple” is how George M. Malis, CEO and managing shareholder at Abbott Nicholson, a business law firm with offices in Detroit and Troy., New Code Section 199A is just one example.
“From a business perspective, I think the tax reform act is very favorable,” he said. “The difficult question is how it affects everyone on an individual basis, especially here in Michigan.”
Here’s a look at five ways Abbott Nicholson predicts that the nation’s first major tax overhaul in nearly 30 years will affect businesses and individual taxpayers.
1. A 14 percent cut for corporations …
The new law’s biggest headline-grabber – a slash in corporate income tax from 35 to 21 percent – could make the United States a tax haven for C corporations, Malis said.
“As a country, our corporate tax rate has been one of the highest throughout the world,” he said. “This is a signal to make us competitive and keep companies in the U.S. I think it has a good chance of working; if we are governed by our own self-interests, why not do business here? But what will be interesting to see is how the rest of the world reacts and what they will do to protect their own turf. It’s too soon to say.”
2. … and a 20-percent cut for pass-throughs
Pass-through entities account for about 95 percent of all U.S. businesses. These nonpublic companies (typically an LLC, S corporation or partnership) don’t pay income taxes. Instead, their profits "pass through" to the owner, who then pays taxes on them at an individual tax rate.
New Code Section 199A lowers a business's taxable income by 20 percent, with the hope that owners will plow that saved money back into their companies by adding staff or purchasing new equipment. This new Code section creates a new tax concept - “Qualified Business Income” (QBI) – generally the net amount of the taxpayer’s taxable income. But from there it gets murkey and a 20% deduction is not guaranteed. In addition, service-type businesses such as doctors, lawyers and accountants don’t qualify for this deduction – but architecture and engineering firms do. But again, there are exceptions to this rule, which is why, Malis said “…this new Code section is anything but simple.”
Several believe that some employees will opt to become independent contractors, so they too can be taxed as a pass-through. But Malis said it’s not that cut and dried.
“The IRS is very aware of this and keen on making sure everyone is pulling out a fair wage, so they are paying into Social Security, Medicare and surtaxes,” he said.
The IRS will keep a sharp lookout for “reasonable compensation” to ensure taxpayers don’t minimize their compensation to lower their tax bill, Malis added.
3. Effect on Michigan Residents
One way the changes hit home – literally – is that residents of Michigan can no longer deduct more than $10,000 of their state/local income taxes and property taxes from their federal tax bill. In addition, as Malis put it, “because the QBI deduction is not a deduction against taxable income, it provides zero benefit to us in Michigan on our state income taxes.”
We’re not alone. Other states, such as New York with its notoriously high property taxes, may review their tax structure to make it more favorable to residents. “Michigan could follow suit,” Malis noted, “but it will take an act of the State Legislature.”
4. No more writing off sexual harassment settlements
In a nod to the current political climate, businesses will no longer be able to write off sexual harassment settlements, including attorney’s fees.
“Many times, the Internal Revenue Code deals with public policy and this is one of those times,” said Malis. “It’s the same as how you can’t take a tax deduction off of a kickback or a bribe. The government is not willing to grant a break for something the Congress perceives to be a bad act. They don’t want to reward taxpayers for that kind of activity. And rightly so.”
5. Estate taxes keep dropping
The new law changes estate and gift tax laws, one of the areas in which Abbott Nicholson specializes. As of January 1, the first $11 million of a person’s estate is tax free – $22 million for a married couple.
“Way back when, the exemption used to be $600,000, then it went up to $1 million, then $5 million,” Malis said. “Congress just keeps making the exemption larger and larger so that fewer and fewer people will have to worry about estate taxes. This is a huge policy shift from when the estate tax laws were first implemented back in 1916.”
Though House Republicans have touted the new tax law as so uncomplicated that many could file on a postcard, Malis said that’s hardly the case.
“Code Section 199A,” he said, “truly flies in the face of ‘tax simplification.’”
Founded in 1977, Abbott Nicholson specializes in corporate/business law, auto dealer and franchise law, labor and employment law, commercial/medical defense litigation, real estate law, tax law and trusts and estates. The firm is the exclusive east Michigan member of Meritas, an affiliation of 186 independent, full-service business law firms with 7,000 lawyers serving 234 markets in 80 countries. For more information, contact George M. Malis at 313-566-2500, gmmalis@abbottnicholson.com, or visit abbottnicholson.com.
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