By Mark E. Battersby / Published February 2019
Last December’s 2017 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, especially those in the pressure washing industry, should begin seeing the promised tax savings when the tax returns for the 2018 tax year are filed but can benefit from the full potential of the TCJA only by planning now.
Every contractor, distributor, and manufacturer undertaking tax planning should be aware the federal corporate tax rate has been streamlined to a flat 21 percent. A new 20 percent deduction for “qualified” income from pass-through businesses may, however, have some S corporation owners and partners in partnerships thinking of changing the entity of their businesses as they could face a tax rate as high as 29.6 percent. But, more about that later.
Among the areas every power washing business owner and manager should be thinking about before the end of the tax year are the following:
Paying bonuses and ensuring the operation doesn’t overpay an owner, manager, or key employee can be complicated. Paying bonuses early or creating a separate bonus payroll might simplify things.
The owner of an incorporated pressure washing business who works in the operation might 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 business, dividend history, employee payments and bonuses, compensation agreements, the amount paid by comparable businesses for similar services, and the use of a bonus formula.
To even the playing field for incorporated pressure cleaning businesses with their new 21 percent corporate tax rate, the TCJA created a 20 percent deduction for income earned from pass-through entities such as sole proprietorships, 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.
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.
Pass-through owners will also need to pay close attention to some removed deductions (including personal exemptions and the deduction for state and local income tax) and the increased standard deduction.
Though the end of the pressure washing operation’s tax year has come for 2018, several general rules might help guide it to real tax savings—savings that will be consistent, year after year:
Once the work is done and the alternatives tested, do you opt for a series of aggressive year-end tax strategies? Above all, make sure the business is actually spending money and not just moving it around, as otherwise, how can anyone hope to know how much the tax reform bill will affect them? If the pressure cleaning operation’s tax professionals are not already involved in the planning process, now might be a good time to enlist their aid.