By Jeremy S. Herman, CPA – Tax Partner with Plante Moran
The Tax Cuts and Jobs Act (TCJA), passed just a few days before the close of 2017, is a significant piece of legislation and affects nearly everyone in the senior housing industry — no matter the size, specialty, market or corporate structure.
As with any tax change, what may seem simple on the surface tends to be much more complex upon closer examination. This complexity, while frustrating at times, can also provide a lot of opportunities for planning for senior housing entities.
This series of articles will summarize key areas of the law that could impact senior housing. This second installment covers a variety of topics, including entity choice, business interest expense, and changes to meals and entertainment deductibility.
1. Entity choice
Since corporate tax rates will decrease substantially while pass-through business (S Corps, LLCs, Partnerships) tax rates will decrease by a lesser amount, C corporations may look more attractive than before—on the surface. Many other considerations that go into decisions about entity choice, however, will not change, and in many cases, a pass-through structure may still be more advantageous.
The tax burden on owners, partners, and shareholders of S corporations, LLCs and partnerships — who pay their share of the business’ taxes through their individual tax returns — will be potentially lowered by a 20% deduction. The 20% deduction is prohibited for anyone in a professional service business, including those in the fields of health — unless their taxable income is less than a certain threshold.
If the owner or partner in a pass-through also draws a salary from the business, those wages are subject to ordinary income tax rates. To prevent people from re-characterizing their wage income as business profits to get the benefit of the pass-through deduction, the tax law places limits on the deduction, as follows:
- W-2 wage limitation – the deduction cannot exceed the greater of:
- 50% of the amount of W-2 wages paid to employees by the business
- 25 % of such W-2 wages, plus 2.5% of the original acquisition cost of depreciable property
- Both limitations phase-in for taxable income between $157,500–$207,500 for a single return and $315,000–$415,000 for a joint return.
Even with these limitations, there are plenty of planning opportunities to allow income to be taxed at more favorable rates.
The new law reduces the corporate rate to 21% from 35%, for tax years beginning after Dec. 31, 2017. The bill also repeals the alternative minimum tax on corporations. Fiscal-year corporations will use a prorated rate based on the number of days in the 34% and 21% tax years, respectively.
While this lower rate may seem to be a driver for an entity change, corporations are still subject to double taxation, as well as state income taxes, while many pass-through entities are not subject to state taxation at the entity level. A careful analysis should be performed before changing the entity structure.Business interest expense
2. Business interest expense
Under the TCJA, the deduction for business interest expense is limited to the sum of business interest income plus 30% of the “adjusted taxable income” beginning in 2018. Adjusted taxable income is defined roughly as a tax-basis EBIDA for the 2018 through 2021 tax years and tax-basis EBIT beginning in 2022 (meaning depreciation and amortization will no longer be added back in later years).
The limitation applies to both C corporations and pass-through entities. There will be exceptions for certain small businesses including senior housing developers and construction entities, such as those with less than $25 million in average annual gross receipts for the prior three years.
The table below summarizes some of the intricacies of the business interest expense analysis:
CAUTION: There is a trade-off to be considered for real estate entities: Real estate entities can “opt out” of the business interest expense limitations, but they will have to forego the opportunity to take bonus depreciation (first year expensing of a percentage of the business asset purchase price) and extend the useful life of their assets (slowing down depreciation expense). Careful computations will need to be performed to determine which approach is best—both today and looking forward to future years.
3. Meals and entertainment.
The tax law disallows the deduction of all entertainment expenses, which are currently allowed up to 50% for business-related entertainment. This also includes membership dues with respect to any club organized for business, pleasure, recreation or social purposes. Meals provided to employees in facilities qualifying for de minimis fringe benefit treatment (tax-free) are now subject to a 50% limit as are meals associated with travel.
This will require providers to look at the money they spend on things like sporting event tickets and customer entertainment to verify (1) future deductibility and (2) if the cost is providing the business benefit.
Stay tuned for the last part of this series, addressing tax reform impact to individuals and the expansion of the definition of small business in relation to their tax accounting methods.
Jeremy S. Herman joined Plante Moran in 2004 and currently is tax director of the firm’s Cleveland office.
Plante Moran is headquartered in Southfield, Michigan, and is one of the nation’s largest certified public accounting and business advisory firms.