Last December’s Tax Cuts and Jobs Act (TCJA) presents both a challenge because of its wide-ranging scope and an opportunity to reap a share of that law’s much-touted tax savings.
Small businesses, including many chiropractic practices, should begin seeing the promised tax savings when their tax returns for the 2018 tax year are filed—but you can benefit from the full potential of the TCJA by planning now.
Every chiropractor undertaking tax planning should be aware the federal corporate tax rate has been streamlined to a flat 21 percent. The new 20 percent deduction for “qualified” income from pass-through practices and businesses may, however, have some thinking of changing the entity of their practice as they could face a tax rate as high as 29.6 percent. But more about that later.
Profits from change
Among the areas every chiropractor should be thinking about before the end of the tax year are:
Write-offs. A chiropractic practice is now allowed to fully write-off the entire cost of new fixtures, equipment and other practice assets thanks to 100 percent “bonus” depreciation. With bonus depreciation, expenditures can be written-off in the year the assets are placed into service—in lieu of depreciating the cost over a number of years. There is also the increased Section 179, first-year expensing write-off that has been doubled from $500,000 to $1,000,000. Section 179 now also includes fire protection, alarm systems and security systems.
Repairs. In 2013, the IRS issued new regulations that kicked in during the 2016 tax year and impact every chiropractic practice with fixed assets. Today, the “de minimis” safe harbor deduction for materials and supplies has been increased from $500 to $2,500 for those practices without an applicable financial statement. It is not too late to update the chiropractic practice’s policy differentiating repairs from capital expenditures to comply with the updated regulation.
Abandon don’t sell. If equipment or other assets have no value to your practice, the benefits of abandoning them rather than selling might be rewarding. Abandonment could generate an ordinary, fully deductible loss, rather than treating the loss as a capital loss, which is subject to limitations. Of course, abandonment must be documented and the property really abandoned.
Writing off entertainment. Business-related entertainment, amusement or recreational expenses are no longer deductible after the TCJA. Business meals, of course, remain 50 percent deductible.
Family and medical leave tax credits. As part of the TCJA, you are now able to claim a tax credit, a reduction in your practice’s tax bill (as opposed to a deduction in the income that tax bill is based on) on wages paid to qualifying employees while they are on family or medical leave. In order to claim the credit, there must be a written policy that provides at least two weeks of paid leave annually to all qualifying employees who work full time. What’s more, the paid leave must be no less than 50 percent of the wages normally paid to the employee.
Limiting the deduction for business interest. The TCJA restricts the deduction to 30 percent of the practice’s adjusted gross income. Questions remain about what constitutes investment rather than business interest and how the limit should be applied to pass-through entities and consolidated groups. (Note: Corporate debt is considered to be business interest rather than investment interest.)
Fortunately, an exception exists for small practices and businesses defined as those with gross receipts that have not exceeded a $25-million threshold for a three-year period. The exception aims to protect their ability to write-off interest on loans for starting or expanding a practice, hire workers or increase paychecks.
Vehicle expenses. What percentage of a vehicle used by the chiropractor for his or her practice is attributable to the business usage? Whatever the percentage, the vehicle may qualify as an auto expense. The IRS allows two ways to calculate the deduction. First, there is the actual expense to which the percentage is applied to create the auto expense deduction. Or, tracking the actual mileage for business purposes and using the 54.5 cents per mile standard write-off.
Don’t forget those carryovers. Deductions for capital losses, net operating losses, home office deductions and even large charitable donations that cannot be fully used in one year may be carried forward to future years. Because these items have a way of slipping through the cracks, make sure to track these deductions and note carryovers from the current tax year’s return. Net operating loss (NOL) carrybacks, of course, are no longer permitted.
Reasonable compensation and year-end bonuses
Paying bonuses and ensuring the practice doesn’t overpay a principal, manager or key employee can be complicated. Paying bonuses early or creating a separate bonus payroll might simplify things.
The principal of an incorporated practice who works in the operation will want to carefully consider his or her salary. S corporation owners benefit from a low salary because amounts that aren’t salary escape payroll taxes.
On the other hand, owners of regular ‘C’ corporations generally benefit from a higher salary and lower distributions. While employment taxes are paid on the salary, the earnings paid as salary are only taxed once. Earnings that are distributed as dividends are taxed twice, once at the corporate level and a second time at the individual level.
The IRS frequently challenges salaries if they deem them unreasonable. While factors used by the courts to determine reasonable compensation vary, the IRS typically looks at training and experience, duties and responsibilities, time and effort devoted to the practice or business, dividend history, employee payments and bonuses, compensation agreements, the amount paid by comparable practices for similar services and the use of a bonus formula.
The pass-through conundrum
To even the playing field between incorporated chiropractic practices or businesses and the new 21 percent corporate tax rate, the TCJA created a 20 percent deduction for income earned from pass-through entities such as sole practitioners, partnerships and S corporations. While eligible taxpayers may be entitled to the deduction of up to 20 percent of qualified business income (QBI), for those with taxable income that exceeds $315,000 for a married couple filing a joint return, or $157,500 for all others, the deduction is subject to limitations.
How the IRS will eventually define “qualified business income” (QBI), and what constitutes a “specified service business” resulting in a limited deduction is an open question. If a taxpayer’s income exceeds the limits, the exceptions apply to pass-through entities involving the performance of services in a number of fields such as health, law and accounting and those where the principal asset is the reputation or skill of one or more of its employees.
Planning before year-end
As the end of the practice’s tax year approaches, several general rules might help guide you to real tax savings—savings that will be consistent, year-after-year:
- Don’t spend money simply to reduce taxes. After all, $1 spent does not equal $1 worth of tax saved nor create a $1 deduction. Also, if those accelerated deductions result in a net operating loss (NOL) as mentioned above, it can now only be used to offset tax bills down the road—there is no longer a NOL carryback.
- Know thy accounting method. Most year-end tax strategies work best for cash-basis taxpayers. Accrual-basis chiropractic practices report all income in the year it is earned and all expenses in the year they are incurred. A practice paying for a 2019 expense during the 2018 tax year doesn’t always result in an immediate deduction on the 2018 tax return.
- Chart a “pro forma” analysis. List your practice’s tax liabilities for 2018 using the new rules, deductions and credits. By using estimated income and expense figures this should not be too difficult. Otherwise, the true impact of “reform” will not be known until the tax return is prepared—when it may be too late to make any moves to reduce it.
- Don’t forget the practice’s entity. Depending on whether a practice files as a “pass-through” entity such as a S corporation or partnership, or as a regular ‘C’ corporation, a significant tax savings might be achieved by changing how the practice files. Obviously, this is not something that happens quickly, meaning the numbers should be run now.
Once the work is done and the alternatives tested, do you and your practice opt for a series of aggressive year-end tax strategies? Or would a more conservative approach lead to a reduced tax bill this year and for years to come? Above all, make sure the practice is actually spending money and not just moving it around. If your tax professionals are not already involved in the planning process, now might be a good time to enlist their aid.
Mark E. Battersby is a tax and financial adviser, freelance writer, lecturer, and author located in Philadelphia. He can be reached at 610-789-2480.
Disclaimer: The author is not engaged in rendering tax, legal, or accounting advice. Consult your professional adviser about issues related to your practice.