By Maurie Cashman
The Republican Caucus will release its tax reform proposal tomorrow. Below is a synopsis of the tax issues you should be aware of that can affect your business and the plans you should be making for transitioning ownership.
Proposals from Trump Administration Expected to be in Republican Proposal
Lowering the tax rate on businesses. Very few small businesses pay the corporate tax rate. If your business is an “S” corporation, an LLC, a partnership, or a sole proprietorship you instead pay on a “pass-through” basis. Profits (or losses) are passed through your business and are taxed at your personal income tax rate. This proposed tax break predominately benefits C-Corporations, the typical structure of very large corporations.
Lowering the tax rate on pass-through businesses. According to the Tax Policy Center this would mostly benefit the wealthy, such as partners in large financial or law firms or land owners. Most small businesses already enjoy this rate, as about two-thirds of all pass-through entities are taxed at 15% or less. A tax cut on pass-through entities would be massively expensive, and the tax revenue would have to be made up elsewhere.
Service company exemption. Treasury Secretary Steven Mnuchin has proposed that service industry companies will not be entitled to the lower business tax rate cited above. Small businesses are heavily in service industries, so they’d be excluded from this lower tax rate. How would technology, distribution, and other non-manufacturing companies be treated? Should they be singled out from those in manufacturing businesses?
Estate tax reduction/ elimination. Proponents of this tax break claims it saves small businesses from the grip of the “death tax.” However, in 2017, the first $5,490,000 of your estate is exempted ($5.6 million in 2018) from ANY estate tax, meaning if your business is worth $5,500,000, your heirs would only pay estate tax on $10,000. By using the combined marital deduction, a business owned by a married couple would have to be worth over $11.2 million before it would be subject to the estate tax.
Only 80 small businesses or farms will pay ANY estate tax in 2017, according to the Tax Policy Institute, representing fifteen hundredths of 1% of total estate tax revenue.
Elimination of mortgage interest deduction. The mortgage interest deduction helps many middle class Americans buy a home. Without it, there’s likely to be fewer home owners, and middle class homeowners hire a lot of small business people — home improvement contractors, painters, carpenters, landscapers and realtors. It appears unlikely that this deduction will be eliminated at this point.
Regulatory Issues That Have Been Settled
Discounts for Interests in Family Businesses. The Internal Revenue Service withdrew on Tuesday October 20, proposed regulations that would have altered the way that certain property is valued for estate and gift tax purposes. Section 2704 has to do with how you value business interests that are transferred for estate or gift tax purposes. The proposed changes to IRC §2704 could have effectively eliminated discounts for lack-of-control and lack-of-marketability in family owned businesses. They ignored economic realities and would have worked to artificially inflate values for a targeted group of taxpayers and not others (and therefore not be applied uniformly to all citizens).
The proposed regulations would have hurt family-owned and operated businesses by limiting valuation discounts and would have made it more difficult and costly for a family to transfer their businesses to the next generation. The proposed regulations would have negatively affected small business owners and family owned businesses, with the ultimate effect of putting many of those enterprises out of business.
Estate and Gift Tax Exemption. For 2018, the estate and gift tax exemption is $5.6 million per individual, up from $5.49 million in 2017. That means an individual can leave $5.6 million to heirs and pay no federal estate or gift tax. A married couple will be able to shield over $11 million ($11.2 million) from federal estate and gift taxes. The annual gift exclusion amount is $15,000 for 2018—up from $14,000 where it has been since 2013.
We will be paying close attention to the proposal that comes out tomorrow to see if these proposals survive and to look for other proposals that can affect you as business owners. These issues are likely to persist as the government struggles to deal with growing debt. You may want to keep these in mind and construct your plans accordingly.
© 2017 Aspen Grove Investments, Inc.