Tax changes could benefit shop owners

March 26, 2018
While it’s unclear exactly how some of the major changes made in the tax code will ultimately affect the economy, there are some clear benefits to be had for many body shop owners.

After months of sometimes raucous debate, the new tax bill passed the U.S. Congress last December. While it’s unclear exactly how some of the major changes made in the tax code will ultimately affect the economy, there are some clear benefits to be had for many body shop owners.  

However, those changes may also lead to additional confusion for small business owners down the road, as well as some tough decisions about exactly how to structure their businesses. 

Accountants across the country are already being inundated with calls about how to proceed in 2018 – and any body shop owner considering a change in the business structure to take advantage of any perceived benefits should have along talk with their financial advisor before proceeding.  

Here are a few key changes that could potentially have the most impact on owners of independent body shops and MSOs: 

Corporate tax cut  
If you already operate as a C-corp, your top tax rate just got cut from 35 percent to 21 percent. However, C-corps are still subject to double taxation – both on corporate income and on any dividends distributed to shareholders. 

Should you convert to a C-corp? That new 21 percent corporate rate looks appealing, but converting to a C-corp is not going to be beneficial for a lot of businesses. According to tax attorney Stuart Sorkin, though, shops and MSOs that are in growth mode – and plan to re-invest in the company rather than pay out dividends –  may want to consider it.  

“If you are buying equipment or buying other shops, you need to look more carefully at the concept,” Sorkin says. “If you are an S-corp and need to invest money in your company, the tax rate is 37 percent, so you are lending back at 63 cent dollars to the company. With the 21 percent corporate rate, you have 79-cent dollars. It’s more tax efficient.” 

For owners that plan to transfer the business to a family member through a stock sale or those selling to a third party, the decision to remain an S-corp or C-corp could impact the tax bill on the sale.  

“The choice of business entity is a more significant issue than it was previously,” Sorkin says. “If you run a C-corp like an S-corp and just strip out all the money, then converting to a C-corp provides no savings because of the double tax. If you are accumulating money in the company or paying for things in the company in after-tax dollars, then it might make sense.” 

“Nobody should make a rash decision about converting to a C-corp,” says Kevin Kuhlman, senior director of federal government relationship with the National Federation of Independent Businesses (NFIB). “If it looks like it will be beneficial, there are actually some provisions in the law that ease that transition. But there are also increased responsibilities for doing so, in addition to the double taxation.” 

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Small business tax cut  
The new law also includes a 20 percent deduction on qualified businesses income for pass-through businesses (S-corps, sole proprietorships, and LLCs). There are some limitations on that deduction for individuals that are in service businesses (such as attorneys, accountants, etc.) that phase out the benefit based on income levels, but collision shop owners should qualify. That means 20 percent of the pass-through income to the owner is deducted from their taxable income. 

For higher income businesses, the tax deduction is limited to no more than 50 percent of total employee W-2 wages.  

The language of this particularly provision is confusing, and it’s not clear whether a shop owner would be better off taking a lower salary and larger distribution or vice versa. “A lot of the benefits are keyed to a percentage of salary,” Sorkin says. “I have older clients who want to take a salary equal to the Social Security maximum, but that may be contrary to a point depending on how this 20 percent deduction works. It may make sense to take a smaller salary and larger distribution through the pass-through.” 

Keep in mind, though, that the pass-through deduction sunsets after 2025. 

Investment deductions increased 
The section 179 upfront deduction for purchases of equipment has been doubled to $1 million. Companies can also fully deduct large equipment and property purchases during each of the next five years instead of depreciating them. The types of property that can be expensed under section 179 have also been expanded (including HVAC systems, new roofs, security systems, and some furniture). 

“If you have to buy a framing machine and you can write that off over one year instead of taking depreciation, that helps you from a tax position,” Sorkin says. “Where you have to be careful is if you are using financing. If you are buying for cash, the write-off is great. If you you are financing, the out-years could generate a potential problem because when you pay off the loan, the principle payments are not deductible, just the interest.” 

In addition, bonus depreciation under section 168(k) of the tax doe has been extended through 2027 (it was previously set to expire). 

Interest, entertainment deductions are reduced 
MSOs with more than $25 million in revenue will lose the ability to fully deduct interest on loans, credit cards, and other debt. The net interest deduction is capped at 30 percent of Ebitda for four years. 

In addition, companies can no longer write off the cost of business-related entertainment expenses. Miscellaneous deductions for employees have been eliminated, so it will make more sense to have some of these expenses fully reimbursed b the company. 

Changes to the kiddie tax, estate tax  
Under the old rules, any unearned income (such as gifts or investment income) to children that exceeded $2,100 would be taxed at the parents’ marginal tax rate. The rate is now going to be calculated under the tax rates for estates and trusts. 

Speaking of the estate tax, the tax thresholds have been effectively doubled to $11 million for individuals and $22 million for joint filers. And the bill significantly raised the alternative minimum tax (AMT) threshold to $500,000 for individuals and $1 million for joint filers. 

“That’s going to save a lot of compliance effort,” Kuhlman says. “Even if filers didn’t hit that threshold in the past, they still had to calculate it.” 

Net operating losses  
The net operating loss deduction can no longer be carried backward two years (as was previously the case). Losses in 2018 or later can be used to offset up to 80 percent of business net income in any given year. They can also be carried forward indefinitely. 

Simpler accounting options  
For businesses with less than $25 million in annual sales, the new law makes it possible to use the cash method of accounting to recognize revenue and expenses as cash arrives or is spent (versus using the accrual approach). The same applies for recognizing expenses and income from long-term contracts, and will also affect the way inventory is accounted for by those businesses. 

Health insurance  
The individual penalties for not purchasing health insurance will be zeroed out, but not until 2019. Owners who signed up for group insurance through the Small Business Health Options Program (SHOP) must now purchase plans through a broker/agent or directly from the carrier instead of singing up using the website. 

There have been some other changes related to the Affordable Care Act (ACA) that were not part of the tax bill, but that will impact some business owners. The “Cadillac Tax” on high-cost employer-provided health insurance plans has been delayed another two years until 2020.  

“A lot of shop owners might have high-cost insurance, so that tax could be an issue,” Kuhlman says. 

Personal income taxes  
While a lot of the changes can benefit business owners, there may be some downside when a shop owner files their personal income taxes. Deductions have been limited to $10,000 for state, local, and property taxes, and personal exemptions have been eliminated. Depending on their income level, some owners may find themselves in a higher individual tax bracket than last year – those with personal incomes above $200,000 could see a rate hike from 33 percent to 35 percent. 

While the standard deduction has been doubled to $24,000, that may not be enough to make up for the loss of the personal exemption and some itemized deductions. 

Don’t make major changes yet:  
The IRS will spend the next several months writing regulations that will further define how these changes will play out, which may further limit the scope of some of the benefits. 

“Owners will need to adjust withholding and have their employees adjust their withholding in the near future, but other than businesses need to pay attention to any IRS guidance on a multitude of different issues,” Kuhlman says. “Consult with an accountant, and don’t make any impulsive decisions.” 

“They’ve written a thousand-page bill and most people don’t know what’s in it,” Sorkin says. “People are going to see things in the Wall Street Journal and the IRS and Congress are going to try to change parts of the law to prevent any loopholes. No one has found the loopholes yet.”

About the Author

Brian Albright

Brian Albright is a freelance journalist based in Columbus, Ohio, who has been writing about manufacturing, technology and automotive issues since 1997. As an editor with Frontline Solutions magazine, he covered the supply chain automation industry for nearly eight years, and he has been a regular contributor to both Automotive Body Repair News and Aftermarket Business World.

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