Put Thousands in your Pocket – in 40 Days!
Here is our quiz
A. Self-employed home inspectors are right in the crosshairs of the new tax law.
- Not at all. It’s a tax cut.
- True, but only if they are married filing jointly.
- True, sorta, if they make less than $150,500 (filing single; $350,000 jointly).
- True, sorta, if they make more than $150,500 (filing single; $350,000 jointly).
- True, mainly by simplifying everything.
B. March 15 is the deadline for the new tax law’s biggest savings.
The new tax law is so far from simplifying taxes, you probably should make an appointment with your CP or tax preparer now.
It’s a hastily written 500+page hodgepodge, passed with no hearings to clean up goofs, that’s filled with traps for the unwary, surprising complications, and a few nifty silver linings. Zeroing in, more narrowly, for real estate, the new tax law definitely is a tax cut for billionaire real estate wheeler dealers, including the Trump-Kushner family. Some of those Big Dogs now will pay practically no taxes and then hand their wealth down to the kids tax free. We should be so blessed.
For home inspectors, especially successful full-timers, it is likely to boil down to a tax hike – especially if they don’t start tax planning in the next 35 days.
Home inspectors with other sources of income and home inspectors not working as an “S corporation” (S corp) need to be especially careful and on guard.
There are basement stair steps down to a bottom of individual deductions in the new law at the same time as there is an upstairs staircase to increasingly higher tax rates. Individual tax rates now go up to 37%, in seven steps, or brackets (10, 12, 22, 24, 32, 35, and 37% over $500,000 filing singly). The top tax brackets (and tax rate zone) are $426,700 filing singly; and $480,050 married filing jointly (half that if married filing singly – the “marriage penalty” is almost gone). Those are all small tax increases, even though the bracket amounts are a tiny amount higher compared to 2017, because the amount changed is less than inflation. And, yes, the standard deduction is almost doubled (to $24,000 joint) – but the personal exemption is repealed, which nearly takes the total excluded from income back to where it was before.
Simplification? Not. Any mere mortal needs a map.
This is it. PLI’s take is custom written for home inspectors. As usual, you read it here first. (You can’t even buy this stuff from other providers.)
“Pass-Through” Business Taxes
Let’s take it from the top. Unless you are inspecting personally, without any business form like an LLC, you will be reporting business income but the business will not pay taxes on it. Income does not get taxed in the business, as it does for GE or Ford. Those business return will just be a report – because all the money and tax attributes flow through to you individually. You pay taxes on it all on your individual federal tax return. Those reporting businesses – like sole proprietorships, LLCs and S corps – are “pass through” entities in the new tax law. Since “pass through” businesses do not pay taxes themselves, we can go straight to the individual tax return – following the money. (Without getting too far into the weeds, single member LLCs (SMLLCs) are disregarded for federal taxes and file as sole proprietors using Schedule C on Form 1040. Multiple member LLCs and partnerships (PSHIPs) file a separate Form 1065. S corps file a Form 1120S, usually by the 15th day of the 3rd month after the end of its tax year. And since the new tax law is federal, we stick with U.S. taxes and skip state or local issues.)
Taxes on “pass through” business income are the single most important change for home inspectors. But you have to inch through the changes, like wheels in a watch being wound.
First, there is no “silver bullet.” Whether you’re in for a tax cut or a tax hike depends on almost a half dozen moving parts. It is unheard of to have such a wide range of tax outcomes for individual inspectors. The actual impact for any individual taxpayer varies a lot, for a lot of complicated reasons that change. Those reasons include an inspector’s form of business (solo, LLC, S corp); total income; payroll; and more.
So there is no “one size fits all” solution that works for every home inspector.
But we can give you some “turn signals” or “landmarks” that should help.
For all home inspectors working as sole proprietors, single member LLCs, and S corporations (those “pass-throughs”), a check-up is needed under the new tax law. For a fair number, converting their business to an S corp may be worthwhile – but time is short.
March 15 is the deadline for any fix, for calendar year taxpayers.
The most basic new rule is this: Individuals get a 20% deduction from total “pass through” “qualified business income” (QBI). QBI is net income from the business.
That 20% deduction gets limited, reduced, or ultimately eliminated after your total taxable income – which includes QBI plus wages, interest, dividends, retirements, etc. – exceeds $157,500 (single; $315,000 joint).
So if you’re a “pass through” small business and you make $100,000 in profit in 2018, and that’s all your income, you’ll deduct $20,000 from your taxable income. (The 20% deduction is “below the line,” not a deduction from profit. It reduces federal taxable income, not flow through and not Adjusted Gross Income (AGI).)
The 20% deduction basically is a consolation prize for all the small businesses that do not get the massive corporate tax cut in the new law, from a top rate of 35% in 2017 down to 21% now. (And the corporate AMT (alternative minimum tax) was repealed, but not the individual AMT.) Those “pass through” small businesses – LLCs, S corps, sole proprietorships, and partnerships – all get taxed at the individual rates.
But wait. Now you get it; now, you don’t. That 20% deduction for “pass through” small businesses starts disappearing once you cross that $157,500/315,000 line. Here’s how:
Over $157,500/$315,000? – The Disappearing Deduction.
For inspectors with more than the $157,500/315,000 in taxable income, that 20% deduction starts to evaporate. Instead of a flat 20% deduction below the line (from taxable income), the amount of the deduction gets limited by wages paid (or wages paid plus a capital element).
Over $207,500 single ($415,000 married jointly filing), the QBI deduction goes to zero – unless wages or possible equipment purchases buy some more headroom. There are quite a few PLI alums out home inspecting today who are going to face that zero – unless….. Tax planning now is the alternative to funding the record federal deficit that got passed with the new tax law.
There are two steps to the basement short of a zero QBI deduction — between that $157,500/315,000 ceiling for the QBI deduction, and the $207,500/$415,000 basement where the deduction drops to the basement zero.
To buy that 20% deduction back, a business basically needs wages that total twice as much as 20% deduction (which, of course, reduce qualified income and need to be calculated).
If income for a single taxpayer is $182,500 ($25,000 over the limit) or $365,000 ($50,000 over the limit for a taxpayer and spouse), the deduction goes down from 20% to just 10%.
If income for a single taxpayer reaches $195,000 ($37,500 over the limit) or $390,000 ($75,000 over the limit for a taxpayer filing jointly with a spouse), then the QBI deduction drops to only 5%.
The S Corp Option
This is where it may pay to check out converting to a S corp. Corporations can chose to be taxed at the corporate level – a “C corp”—or at the shareholder level – an “S corp.” The “S” actually refers to subchapter S of chapter 1 of the tax code, not to the word “shareholder.” An S corp avoids double taxation – at the corporate level and the individual – because S corps generally pay no taxes. (The few taxes that might apply to S corps, like excess passive income and LIFO recapture – do not apply to any home inspectors we know. So, here, we’ll consider that S corps pass all their income and tax attributes through to their shareholders.)
An LLC can elect its tax treatment. An LLC with one owner (LLC owners are called “members’) can be treated as a sole proprietorship, a C corp, or an S corp. An LLC with two or more members can be treated as partnership, a C corp, or an S corp. There generally are two ways to become an S corp. You can incorporate as a regular corporation and then make a special election asking for S corporation status. Or you can set up a single-member limited liability company and make the S election. Deciding which is best for you takes careful analysis of personal and business cash flows and taxes. You should consult a pro. People who are not hot shots in tax law especially tend to make expensive mistakes.
If you’re a sole proprietor, or in some cases an LLC, and you’re over that $207,500/$415,000 ceiling, do the math with your CPA – including a 5 year forecast – and consider turning to an S corp. (Remember to go over the advantages of S corps when you start paying wages.)
Here’s the nitty gritty of how the new law disappears that 20% deduction:
The 20% deduction gets limited in steps. For taxable income that goes over by up to $50,000 (between $157,500 and $207,500 single; or by $100,000 for joint filers), the deduction gets cut by a percentage of $4,000, depending on a fraction. The numerator of the fraction will be the amount of taxable income over $157,500/315,000. The denominator will be $50,000 single, or $100,000 joint. So, for example, if taxable income is $167,500 ($10,000 above $157,500) for a single filer, then only 20% of QBI would be excluded ($10,000/$50,000 = 0.20)
If taxable income is more than $50,000 (single/$100,000 joint) above the caps (above $207,500 single), your deduction is cut to not more than either (1) 50% of your share of W-2 wages paid by the business or (2) the total of 25% of W-2 wages plus 2.5% of unadjusted basis of tangible depreciable property used in the business, including real estate (based on the acquisition cost), whichever is more.
Essentially, you need wages that total twice as much as the 20% deduction. It takes wages of at least $40,000 to get back to that 20% deduction.
The deadline for electing S corp status is March 15 this year (for calendar year taxpayers). Just to complicate it even more, you would be stuck with that election for 5 years.
If you elect to become an S corp, new rules kick in. Wages paid will become the key.
For S corps, there’s a tradeoff between wages you pay yourself, and self-employment tax, even though S corps deliver real opportunities when it comes to self-employment taxes.
To make the S corp fractions work, be cautious. You do not want to “over-wage” yourself. You cannot amend a payroll tax return s- without sending an invitation for an audit.
Remember too that converting to an S corp may deliver other tax benefits, compared to a sole proprietorship.
For example, think deducting insurance.
(One hedge: All this assumes that home inspectors are not in a special category of “specified service businesses,” like lawyers, financial types, etc. But the wrinkle is that the definition of “specified services” includes consulting or where the principal asset is the reputation or skill of one or more employees or owners. We doubt that “specified service businesses” will include home inspectors, but the IRS regulation on what’s in is not out yet, and it leaves room for uncertainty right now.)
So if you’re a sole proprietor or single-member LLC and your QBI is over the $157,500/315,000 ceiling, now – before March 15 — is the time to visit with your CPA or tax preparer and kick around the S corp form of business.
When you do, be sure to get a grip on all the advantages and disadvantages of being a S corp. The are other attractive tax saving opportunities in an S corp (some depending on the number of employees), like exempting your “distributive share” of profits from the 15.3% self-employment tax (FICA 7.65% times 2 – the employer and employee portions) and the 0.9% Medicare surtax that applies to your wages. (There also are disadvantages. For instance, some family members may not count as employees for some purposes in S corps.) You know what’s coming: Check it out with your tax advisor.
A Couple Million $?
A handful of inspectors among PLI alums are making a couple million in pass-through business income. For these highly successful inspectors, there might be opportunities to elect converting to a C corp, particularly if you can wait to take dividends or some of your pay. Even so, be careful to discuss “reasonable compensation.” If you’re possibly in that category, you really need to see your CPA ASAP!
Other Deductions & Opportunities
There are other parts of the new tax law that may affect your tax return too. This can’t cover them all, but it can highlight a few that are likely to be important to most home inspectors.
If you’re not taking a home office deduction now, it’s time to take another look. The depreciation recapture (when the home is sold) is eliminated in the new tax law if you choose the simplified method and have not depreciated the home before.
There’s also an opportunity in capital investment. You can get a 100% write-off on new equipment. Most types of equipment, including software and technology, now qualifies for Sec. 179 depreciation the year you get it – whether you buy it outright, finance it, or lease it (provided it qualifies as a capital lease). This is another disappearing deduction that is scheduled to phase-out over just a few years from now.
Most of you recall that Steve’s “acid test” for both your business plan and home inspection pricing, is whether you make the maximum tax deductible and deferred retirement plan contributions this year. The contribution limit for deferrals (to 401(k), 403(b) and 457 plans) goes up by a measly $500 to $18,500. The total limit on contributions by you and your employer combined is $55,000, up $500 each. (The extra catch-up amount for people over age 50 stays unchanged at a shameful $6,000. And then, in the next breath, the politicians complain about underfunded retirement plans.)
Most home inspectors should put the maximum $5,500 ($6,500 if over 50) into their Roth IRA first if they are not going to contribute the overall maximums. You can keep contributing to Roths at any age – as long as you’re sill earning adequate self-employment income or wages. (Contribution limits change, and get eliminated, starting at $120,000/$189,000 modified AGI.)
You also should be stashing $3,450 (singly; $6,900 family, plus $1,000 if 65 or older) this year, every year, in a Health Savings Account (HSA). An HSA is the single best tax deal for individuals on the books (though the deal does not get improved under the new tax law). HSAs are “triple tax advantaged” – which means (1) the money you put in reduces your taxable income; (2) the money you spend on qualified healthcare is never taxed; and (3) gains in the account are free of capital gains taxes. You can sign up and contribute online. The younger you are, the better the deal – but it’s never too late.
More broadly, outside our basic inspecting business, many home inspectors also are real estate investors. There’s a whole other story in that field under the new tax law, and a Christmas tree of opportunities. But that’s well beyond the scope of this article. If you’re both a home inspector and a real estate investor, do not delay. Consult your CPA right away.
Otherwise, the new tax law takes a meat-axe to lots of deductions people used before. Even the deduction for paying your CPA or tax preparer for doing your tax returns gets axed for most people (but not if you’re self-employed)! They complicate the law like this and then take away the deduction for paying a pro to figure it out. That takes brass.
Casualty and theft losses? No more (unless you’re like Puerto Rico and it’s a federally declared disaster). Unreimbursed employee expenses. Adios. Moving expenses? Gone (for practically everyone, except for some military personnel).
But one deduction is worth watching. If you thank agents and referrals with gift cards, that can be deducted – as long as you don’t go to the restaurant with them. Turn it into a business meal or entertainment – by going with them, instead of just sending the gift card — and you probably lose the deduction.
Millions of people will decide not to bother itemizing deductions now. The home inspectors among them are among the most likely Americans to get the shaft – and take the elevator to more taxes.
All the changes discussed in this article are in effect for 2018, so you will see them on your 2019 federal tax return. You can’t plan for that future in the future.
Corporate Limits of Liability
All inspectors should keep in mind that working as a “statutory entity” — like an S corp or LLC — is discussed here only from the point of view of tax planning. That’s not the whole picture for any business. There are quite a few things to consider for any business entity. But one that we hear often is that being an LLC or S corp is a “shield against liability.”
As a limit on liability, a one inspector S corp or LLC is not much good. Plaintiffs will practically always sue the inspector and the company. The shield against liability basically kicks in after a business has other employees.
This Is Unlikely to Last Long
One last thought: None of this may last. Important parts may crash and burn near the end of the year, after the mid-term elections.
So if you’re thinking about buying expensive equipment in a few years, it may be worthwhile to do the deal sooner.
This whole tax setup may not last, and choices get more complicated right now, because there are unusually good odds that this law may get substantially amended or repealed. This is especially a concern for any 5-year election, and means that 5-year outlook needs to be cold steel realistic.
The new tax law got passed entirely on Republican votes in Congress. Major legislation passed by any one party has always been torn up or repealed entirely as soon as the other party gets more votes. Think “Obamacare” – passed entirely on Democratic votes. This cumbersome and widely criticized tax law is unlikely to be an exception. If Democrats regain control of Congress in this year’s midterm elections (and they appear likely at the moment to win the House), expect changes.
Heads up! Here’s The Usual Disclaimer:– No one knows the details yet. The new tax law is only 40 days old as this is written. New rules filling in details are not even out yet. Everybody is still working hard to figure out how the new law works – taxpayer by taxpayer. And remember: PLI is an educational institute and our Newsletters are an information service. These articles are “overviews” and general rules that may or may not apply in your specific circumstances. No article is any substitute for individual, specific tax, legal, and accounting advice. These reports are news about new developments, including laws and taxes — but not tax advice. For tax advice, now more than ever, you must consult your professional tax advisor or CPA.