Business Structure Shake-Up
The new tax code causes laboratory owners to reevaluate
Bruce Bryen, CPA, CVA
With all of the changes in the new tax code, many laboratory owners may be wondering whether their legal organizational structure is the best for receiving the maximum federal tax breaks available. The following includes answers to a number of common questions that you and other small businesses may have from a legal-business perspective.
Is the laboratory's legal format the best for the owner from a federal tax perspective while other concerns may also exist?
The current thought of many laboratory owners is to make sure that they take advantage of the new pass-through concept with an LLC, LLP, S corporation, sole proprietorship, etc, so the income or loss from the laboratory flows through onto the owner's personal tax return. For income that flows through to the laboratory owner, with certain limitations, the laboratory owner will enjoy up to 20% of that amount as nontaxable income. This is an incredible deduction available for the laboratory owner starting this year. This means that after all business deductions on the laboratory income statement, whatever is left as taxable profit gets reduced by an additional 20% prior to the federal tax being computed. Since many state tax returns and their taxes are based on the income reported on the federal tax return, this may have an additional positive effect based upon each particular state's allowance of this new federal income deduction. There are, of course, other reasons why the existing tax filing status and business structure of the laboratory were chosen. In many cases, a great deal of time and money was spent in researching the current format.
Should a new legal entity be formed, or should the existing entity be converted to a new one?
If any laboratory is not legally organized as a pass-through entity, such as a C corporation, it would probably make sense to at least speak to the laboratory's professional advisor, such as the CPA for the laboratory owner, to make that determination. The new tax rules for C corporations may cause the CPA to advise the laboratory owner to keep the legal format since the tax rates are so much lower for C corporations now. The cost of that advice will be well worth it based on what steps must be completed to advance the process to the best advantage for the laboratory and laboratory owner based on the new tax law. Questions about owner liability, asset protection, and estate asset preservation all need to be answered as part of the analysis of this important review. It may be that income and asset projections must be completed and reviewed by both the CPA and the attorney for the laboratory. The important point is that the laboratory owner realizes that things may be different than in the past, and the time is right for an overview of what currently exists.
If a change in entity structure is needed, what happens to 401(k) plans and other fringe benefits available to employees?
The answers to these and other questions are additional reasons why advice should be sought from the CPA and possibly the attorney for the laboratory, since tax considerations are not the only reason for changes to a legal structure. Sometimes money is not the only point in discussions about why certain decisions are made. The various legalities in the different entity formats may allow certain business advantages but could create disadvantages to life planning strategies, as well. Inheritances and divisions of assets are usually keys to the decisions about how changes interface with other areas of interest regarding the ownership of the laboratory. When it comes time to sell or have a family member join as an owner, these non-monetary views are important and may overcome the savings of federal tax monies today. In a situation where there are children or more than one marriage and children from each, a long discussion and review of the consequences of change are normally necessary. Upsetting a family dynamic is typically not worth the financial savings that are considered over the long term. These types of instances cause emotional and also financial pain at a later date.
What about real estate or leasehold improvements and equipment purchases? What is the best legal entity for these acquisitions under the new tax law?
Just like almost every other question raised regarding the new tax law, general business questions occur all of the time-but especially when something extreme, such as the new law, takes effect. With a pass-through entity, it will pay to plan even moreso than in the past. With the new additional 20% deduction from income prior to determining the tax, consider putting a lot of the depreciable items on hold. Prior to the new law, many laboratories would buy equipment before the end of the year in order to enjoy the extra depreciation write-off that was available. Now a large write-off is more readily available on equipment and improvements to real estate. The additional 20% write-off from a federal standpoint will allow additional debt or payment of capital for a fixed asset to be deferred if its purpose is to defer taxes as soon as possible. If the equipment is needed regardless of the tax situation, a longer term for the depreciation expense may be suggested because it is no longer needed as quickly as in prior years. Manipulating the profit to take advantage of the additional write-off that passes through to the owner is something to review with the CPA representing the owner of the laboratory. Another example of using the new law to the owner's advantage is the prepayment of principal. As most laboratory owners realize, the payment of principal can only come from income or from refinancing the debt. If it comes from income, that means the payment has been made to amortize the debt, and there is no money left to pay the tax on the income that was used to pay the debt. Now, an additional 20% deduction can be taken against income on pass-through business structures, so prepaying debt may be a good idea.
About the Author
Bruce Bryen is the principal in the firm of RKG Tax and Business Services, LLC, in Fort Washington, Pennsylvania.