We cannot spend too much time talking to our physician clients about the Tax Cuts and Jobs Act (TCJA) effective this year. Many important changes made will impact all business owners.
In this article, I will touch on the qualified business income (QBI) deduction (available to sole proprietors, LLCs, partnerships and S corporations) and some of the other changes made to routine annual expenses incurred by a practice including depreciation, meals and entertainment, and business-use vehicles.
With regard to the QBI deduction, there are three separate moving pieces to address. First, for married taxpayers, the 20 percent deduction of qualified taxable income is allowed for income generated by medical practices to the extent total income is $315,000 or less. A limited deduction is available on income up to $415,000 after which the QBI deduction is completely disallowed. Second, total income includes income from all sources for both spouses. For example, assume a physician’s share of taxable profit from the practice is $200,000, physician wage income is $100,000 and the spouse’s wage income is $125,000. The easy mistake to make is to assume the 20 percent QBI deduction is allowed because the physician’s share of income is $300,000, which is under the $315,000 threshold. The total income earned by both spouses ($425,000 in my example) must be used to determine whether or not the QBI deduction is allowed. So in this example, no 20 percent deduction of the medical income is allowed. Third, only the physician’s share of taxable profit from the practice, not the wage income, is considered for the 20 percent QBI deduction. Tax planning to get total taxable income just below $315,000 would be important in this example here.
There are beneficial changes made under the TCJA regarding the expensing of capital expenditures (purchases of furniture, equipment and qualifying leasehold improvements). Under prior tax laws, capital expenditures made on brand new assets qualified for a 50 percent accelerated “bonus” depreciation write-off. Effective Sept.27, 2017, capital expenditures made on both new and used assets qualify for a 100 percent bonus depreciation write-off. It is important to note that a bonus depreciation write-off can be utilized even if a business does not generate a net income. For physician practices in start-up or expansion mode, this can be a great option to generate tax deductions in the year of expenditure to help avoid tax bills when collections are slow or cash is tight. For established physician practices, tax planning to utilize this expanded immediate deduction of capital expenditures in order to qualify for the QBI deduction should be considered.
Additionally, accelerated depreciation under Internal Revenue Code Section 179 has been increased to $1 million under the TCJA. Section 179 is allowed to the extent of business profit and can be taken on eligible property, which does not include the cost of a building and land. However, the definition of eligible property has been expanded to include a roof, HVAC and security system improvements. Again, in consideration of maximizing the potential QBI deduction, further analysis should be given to the accelerated depreciation options when a physician’s overall taxable income is over or under the $415,000 QBI threshold.
The TCJA also made several changes to meals and entertainment expenses. In short, the majority of entertainment expenses are no longer deductible for tax purposes. This includes activities such as taking a client or referral source to a sporting event, concert or theater and also includes amounts paid for membership in a club organized for business or social purposes. Meal costs incurred during entertainment activities are also no longer deductible. Meals with clients, referral sources or prospects with substantial business discussion, on-premise meals provided for the convenience of the employer, and employee travel meals are 50 percent deductible. A holiday party or similar event for employees is still fully deductible.
For practices that maintain a company vehicle for business purposes, the new tax law changed the tax treatment of vehicle trade-ins. In previous years, vehicle trade-ins qualified for like-kind exchange treatment, which allowed for the deferral of the gain recognized from the amount received in consideration of the vehicle being traded in. The new tax law removed vehicles as property eligible for this treatment. Moving forward, when a business vehicle is traded in, taxable gain could be triggered on the transaction to the extent of trade-in value and prior depreciation taken on the vehicle. Tax planning is now even more important when dealing with the disposition of an expensive business vehicle.
There is still a lot of information to unpack from the TCJA. Tax advisors expect much more information from the IRS on provisions within the new tax law that need further clarification. These future clarifications could change the current understanding of the bigger changes, such as the QBI deduction. As such, it is very important that your tax advisor keep you informed about how the new tax law and expected further clarifications will affect your tax situation.
Christopher Davis, CPA, is a Manager with Sol Schwartz & Associates PC and has been practicing public accounting since 2008. Davis practices in various areas of public accounting, including tax compliance and consulting for individual, corporate, S corporation and partnership taxation. He is a member of the firm’s healthcare niche that specializes in identifying and implementing solutions to achieve the goals of the physician clientele we serve. You can contact Davis via email at firstname.lastname@example.org or call him at 210-384-8000, ext. 118.