Businesses are starting to evaluate how to minimize their tax bills as the GOP tax reform plan takes effect.
The measure President Trump signed in December makes a number of significant tax-code changes that impact businesses. Accountants and lawyers are pouring over the pages of the law and are starting to think about how companies can maximize their tax savings.
But businesses are often moving cautiously because they are waiting for the IRS to provide guidance that clears up ambiguities in the law. And the process of businesses developing their tax-planning strategies and the IRS pushing back against actions it views as abusive will occur over a number of years.
“The full extent of this won’t be understood for years,” said Mark Everson, who served as IRS commissioner from 2003 to 2007 and now serves as vice chairman of alliantgroup.
One of Republicans’ top priorities in overhauling the tax code was to improve business competitiveness. Business tax changes in the new law include cutting the corporate tax rate from 35 percent to 21 percent, creating a 20-percent deduction for income of non-corporate businesses known as “pass-throughs” and moving the U.S. to a territorial tax system that generally doesn’t tax American companies’ foreign earnings.
Companies are in the early stages of figuring out how they might want to restructure — and what investment decisions they may want to make — in order to best take advantage of the new law.
A top issue that businesses are contemplating is whether they should be organized as traditional corporations or pass-throughs. Companies have until March 15 to make an election if they want to change their entity status for the entirety of 2018.
Corporations have their income taxed twice: once at the entity level and again when earnings are paid to shareholders. Pass-through businesses, on the other hand, only have their income taxed once; they have their income taxed through the individual code on their owners’ returns.
Under the old tax code, it made sense for many companies to be pass-throughs because they are only subject to one level of tax. But under the new law, some companies might find it beneficial to be corporations because the entity-level corporate tax rate is now much lower and they may not be sure if they qualify for the new pass-through deduction.
Donald Susswein, a principal at RSM, said that if a family owns a business that it plans to keep for a long time, and the family plans to reinvest its profits into the business rather than pay dividends, “then corporate status is desirable because at least in the short run the rate is lower.”
On the other hand, business owners who are planning to sell their companies in the near future may benefit from remaining pass-throughs, he said.
The tax law also has new restrictions on businesses’ ability to deduct their interest expenses, so companies with a lot of debt may be looking at paying off debt and finding alternative financing options. And businesses also might look into investing in new equipment faster than they had anticipated, given a new provision, expiring after five years, that allows businesses to immediately write off the full costs of their capital investments, Susswein said.
It will take some time for businesses to fully figure out how they want to restructure due to the new law. Tax experts said that many of the provisions are complicated and will need clarifications from the Treasury Department and the IRS.
“There’s some pretty significant questions that Treasury need to answer just to comply with tax law,” said Ray Beeman, co-leader of the Washington Council Ernst & Young practice.
Gerald Thomas, chair of McGuireWoods’ business tax group, said that “given that this tax reform act … was rushed through Congress in such a short period of time, there is a lot of ambiguity in the new tax provisions.” Trump signed the tax law less than two months after the House first introduced a version of the bill and just days after the final version was released.
Provisions on the pass-through deduction and the international tax rules are among the top areas where businesses are seeking guidance, and are among the 18 topics on the IRS’s list of areas where it plans to issue guidance to help with initial implementation of the tax law.
Acting IRS Commissioner David Kautter told reporters after a hearing earlier this month that the pass-through and international areas are the places where there will need to be the most work on guidance, since the law creates new systems in those areas.
“Those are the two areas where I think we’re going to have the greatest lift in terms of building something that’s broad and deep and new,” he said.
As time goes on, businesses may discover loopholes in the law that allow them to keep their taxes low in ways that the drafters of the tax law did not intend. In these cases, the IRS may issue guidance to clamp down on behavior it perceives to be abusive, and Congress may have to craft new legislation to provide fixes.
One example of Treasury planning to crack down on a business behavior has already popped up. Following a Bloomberg report that hedge-fund managers were taking actions to try to get around new limits on the carried interest tax break, Treasury Department Steven Mnuchin said that the department would issue guidance to clarify that that behavior is not allowed.
“That’s something we believe we have the authority to do,” he said.
Everson said that Congress and the IRS would have to stay abreast of businesses’ actions.
“We’re at the beginning of a very long and continuous process here,” he said.