s
s
Sections
Sections
Subscribe

“If you have a lot of debt on your books and you’re going to try to deduct interest, that’s going to be lowered.”

—Buddy Wall, tax partner at Moss Adams

“Because it’s so capital intensive, some of our startup wineries have borrowed quite a bit of money. They were deducting 100 percent of the interest expense and had very little income.”

—Jim Caven, specializing in wine at Pisenti & Brinker’s Napa office

Nearly six months after the federal tax law changes passed in late December, accountants are making recommendations to their business clients about strategies they should consider for their 2018 filings.

Those include dealing with changes in amount of interest deductions allowed, something that could have implications for wine industry, and certain tax implications based on which revenue accounting method to use.

But Ray Pounds of Pisenti & Brinker, a 50-person firm with offices in Santa Rosa, Petaluma and Napa, said, “Probably the most significant change that has not been a factor in some time is choice of entity.”

The choice Pounds means is between being a C corporation or an S corporation under U.S. tax law.

For-profit businesses are automatically incorporated as C corporations, which pay corporate taxes, but they can, if they meet certain ownership rules, elect to become S corporations, which pass profit or loss through to their shareholders, who then pay individual taxes. Shareholders of C corporations are thus “taxed twice” in a sense.

For many years, Pound said, the difference between corporate and individual tax rates made S corporation registration attractive, depending on the type of business.

When tax changes in the 1980s lowered the individual tax rate and increased the spread between personal and corporate rates, his customers began looking at S corporation registration with more interest.

“When the corporate tax rate was 34 or 35 percent and the individual rate dropped to 28 percent, people said, ‘Now’s the time to think about going to an S corporation,’” said Pounds, who started work as an accountant in 1972, as soon as he graduated from University of California, Berkeley. “Everybody raced to the IRS to change — those who could qualify.”

But the changes coming for 2018 turn that historical situation on its head, he said. “The C corporation rate is 21 percent — that’s a free fall from 34 or 35. Now you’ve got the reverse where individual rates are higher.”

Caveat C corp.

But though the drop to a flat 21 percent tax rate for C corporations might make some business owners consider changing, most accountants still counsel caution.

“Don’t do anything drastic,” said Buddy Wall, a tax partner at Moss Adams, who works in the firm’s Fountain Grove office in Santa Rosa.

Although changing from an S corporation to a C corporation isn’t at all difficult, there are complex ramifications that aren’t easy to predict. And switching back to an S corporation again isn’t possible for five years.

“The problem is that if you elect to become a C corp., you’ve got to wait five years,” said Wall. “You’ve really got to run the numbers by your CPA. Are you going to sell the company? If you are, it’s better to stay an S corp.”

Different types of businesses also have different needs that are better met by being one type of corporation or the other, Wall said. Many of his clients, for example, are in the construction industry, and have different cash needs than, say, someone in retail or agriculture. A flow-through S corporation model fits them better.

“When it comes down to it, I’m still a flow-through guy,” Wall said. “Most of my closely held clients take money out of the business above their taxes. For construction, I don’t see anybody switching over to C corp. They’re going to pay less tax with the flow through. It’s still beneficial to be an S corp. and an LLC.”

“If you have a lot of debt on your books and you’re going to try to deduct interest, that’s going to be lowered.”

—Buddy Wall, tax partner at Moss Adams

“Because it’s so capital intensive, some of our startup wineries have borrowed quite a bit of money. They were deducting 100 percent of the interest expense and had very little income.”

—Jim Caven, specializing in wine at Pisenti & Brinker’s Napa office

Pounds emphasized that it is an individual decision tailored to each particular business, even if the same person owns more than one company.

“I’ve already had one client that converted from an S corporation back to a C corporation because they wanted to take advantage of the tax dollars,” Pounds said. “But they have another business that stayed an S.”

Interested in interest

Another change in tax code that accountants are studying for their clients is a new limit on how much interest expense can be deducted from a company’s federal taxes. This change particularly affects the wine industry, said Jim Caven, who specializes in that sector, working out of Pisenti & Brinker’s Napa office.

“There’s a limitation rule on how much interest expense that you can take against your adjusted income — 30 percent,” said Caven. “Because it’s so capital intensive, some of our startup wineries have borrowed quite a bit of money. They were deducting 100 percent of the interest expense and had very little income. We have to at least look at this because they may have a disallowance of the interest expense.”

This is a serious change, agreed Moss Adams’ Wall.

“If you have a lot of debt on your books and you’re going to try to deduct interest, that’s going to be lowered,” he said. “If there’s a business with a lot of debt they should probably be looking at that and have their CPAs run the numbers.”

Caven said struggling startup wineries hit by this change may have to consider other options. “Look at other investors or put in more capital of your own,” he said.

The check is in the mail

A third significant change in the code is a higher revenue threshold for the cash method of accounting rather than the accrual method.

Under the cash method, payments a company has billed a client for but that they haven’t received yet — say they sent an invoice not due for 90 days — aren’t counted as revenue. The accrual method, however, counts those as-yet-unpaid invoices as revenue that is subject to tax.

The tax law passed in December raises the threshold from $10 million in revenue to $25 million, so that more companies will now be eligible to use the cash method if they choose. Businesses over $25 million will still be required to use the more complex accrual method.

Pounds explained that this change could simplify some reporting for small businesses.

“Retailers, wholesalers, those who create or buy and resell inventory items — that’s their main revenue source,” he said. “They were required to be on the accrual method. This change may generate some more interest among companies that have a higher revenue threshold.”

However, as with all the other changes, Pound stressed the need for caution and taking the long view. Changing the timing of incoming revenue payments can have a short term positive tax effect, but ultimately things even out. The fundamental issue is whether the change will be good for the business itself.

“Is there going to be a benefit of doing it? Once you make the change the benefit is gone. You create the same cycle and after a while it averages out,” he said. “You don’t want to start making inventory decisions based on tax rather than other factors.”

Clarifying the code

One reason accountants are counseling clients to keep cool is that, although the tax law has been passed and published, the IRS hasn’t yet written and put out detailed regulations explaining how everything’s going to work.

“There are a lot of interpretations that still have to be dealt with on how they’re going to define certain kinds of entities,” said Pound. “There are a lot of idiosyncrasies. We’re hoping through the course of the year that the Treasury Department will clarify the code and write regulations for it.”

An example of where the code is still unclear, said Wall, involves a 20 percent deduction for qualified business income for some businesses. But which ones, exactly?

“It’s really every type of business except specified trade service businesses — attorneys, accountants, doctors, any business where the principal asset is the reputation or skill of one or more employees,” he said. “There are no regs on that yet, so we’re not quite sure. We get questions from clients — ‘Do I get this deduction?’ A contractor, yes you get it. But what about vineyard management? What about a real estate agent?”

As for the detailed regulations, they should arrive in time, Wall said.

“They’re working on the regs now,” he said. “We will probably start seeing some of this later in the summer. They know they’ve got to get them done.”