The new Tax Cuts and Jobs Act (TCJA), which took effect at the beginning of this year, covers a wide range of taxes, largely focused on taxes for businesses.

The new law permanently established a flat 21 percent corporate income tax rate, which also applies to personal service corporations (PSCs), but rates remained higher for individual taxpayers – which is problematic for sole proprietors and owners of pass-through businesses such as S Corporations and Partnerships.

As a workaround, Congress included a deduction of up to 20 percent of pass-through earnings to lower the income tax rate. The new law also exempts engineers and architects from the definition of “service businesses,” which are not allowed the 20 percent deduction of qualified business income (QBI) if their owners have more than $157,500 of individual income (or $315,000 married filing jointly).

Here's an important distinction: If your firm qualified for the Domestic Production Activities Deduction, and then lost it with the TCJA, then you should meet the “architects and engineers” definition. If you are over the limit on your personal income, the calculation for engineers and architects includes the W-2 wage limit test. You may also be interested in an earlier article and flowchart by T. Wayne Owens & Associates (TWO) covering the implications of the TCIA on architecture and engineering firms.

At Last, Some Clarification

This complex new law created a stir of confusion earlier this year, but on August 8, 2018, the IRS issued proposed regulations for Section 199A, to clarify some of the concerns. The 199A deduction will reduce the amount of taxable income attributable to your business, including sole proprietors and business owners with pass-through businesses.  The law became effective as of this calendar year – so you’ll be able to claim the deduction on your 2018 federal income tax return. Click here to download the 184-page PDF of the proposed rules 

Highlights for A/E Firms

The proposed regulations provide further changes and guidance on most issues, but not all. The following are some key points that A/E firms should be aware of.  

• A/E firm owners who have a separate company for the purpose of building ownership (which is great tax planning, but bad overhead rate planning!), will be treated as owning a separate trade/business, even when renting to a related party or business.

• The proposal addresses the possible avenue of abuse, where multiple trusts are used to avoid income and specified service trade or business (SSTB) limitations of the 199A rules. The Section 199A anti-abuse rules apply to tax years ending after December 22, 2017.

• Good News! The 199A deduction has no effect on the adjusted basis of stock in an S-Corp, or basis in partnership by partner. Further, the new law does not subject the individuals to the alternative minimum tax.

• A/E firms will most likely use the W-2 wages test instead of the 2.5 percent of the unadjusted basis of assets test, since firms typically have low fixed assets and high wages. However, a firm heavy with fixed assets (such as labs, underwater inspection, survey equipment, etc.) would need to watch the timing of purchasing additional fixed assets. These proposed regulations include a window during which assets may not be purchased, or cannot be disposed of, unless the taxpayer demonstrates that the principal purpose was business and other than the reason for increasing the Section 199A deduction. (Think about those late December truck purchases made to qualify for Section 179.)

• If you changed your accounting method from accrual to cash for tax purposes, the Section 481 adjustment follows the K-1 and is included as QBI/Deduction for the calculation. Suspended losses are included in QBI in the year in which they become allowable for tax purposes.

• Multiple trades or businesses must properly attribute items to each individual business using a “reasonable” method. Comments are requested on those reasonable methods and possible use of a safe harbor.

• The proposed regulations will allow multiple businesses to be treated as a single business under certain rules. A potential pitfall is that once multiple trades or businesses are combined into a single aggregated trade or business, individuals must consistently report the aggregated group in subsequent tax years.

• If you have multiple businesses, you will calculate QBI for each entity and then net the amounts. If the net amount is a loss, you have a QBI carry forward to the next year.

• The proposed changes include a de minimis rule that will keep a business from being treated as an SSTB if gross receipts are under $25 million in a year (the majority of A/E firms), and less than 10% gross receipts attributable to a specific service (kicks the A/E firm back out).

• If your firm uses temp agencies, you can use the wages paid by the temp agency to compute your 199A deduction.

The proposed rules under Section 199A will enter a comment period before final rules are published. TWO will continue monitoring the regulations and any further clarifications or changes, and will send updates via our email newsletter.

About the Author:  Mindy L. Toole, CPA, CGMA, CDA, is the tax partner with T. Wayne Owens & Associates , PC, a CPA firm with a singular focus on the design industry, providing accounting services, overhead audits, financial statement audits, tax returns and more to A/E/C firms. Contact her at mtoole@twocpa.com.

You can also meet T. Wayne Owens & Associates  at THRIVE 2018. They are a sponsor and exhibitor at PSMJ's annual conference to held October 22-24 in San Diego. THRIVE 2018 is your chance to learn, to network, and to get an eye-opening perspective on what the world’s most successful A/E/C firms are doing right now to thrive. This unique annual conference attracts senior-level executives from a wide range of A/E/C organizations located around the world.