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Incorporated optometry practices can expect reduced tax rate with new law
With one major change, the cost of equipment can be deducted fully and immediately.
Signed into law in December 2017, the Tax Cuts and Jobs Act contained a treasure trove of tax breaks – along with several potential pitfalls – for small businesses and optometry practices.
The Tax Cuts and Jobs Act (TCJA) makes sweeping modifications to the tax law, including a much lower, 21%, corporate tax rate. In our last article, “Tax Cuts and Jobs Act brings reduced personal tax rates, brackets,” February 2018, pages 1 and 8, we covered coping with pass-through income, but what about the changes made to the tax credits and deductions every professional practice encounters?
Cost recovery – increased expensing
Unlike past years, when an optometry practice was required to claim depreciation, spreading the recovery of their equipment costs over several years, many optometrists will now be able to fully and immediately deduct the cost of certain equipment. Used equipment will now qualify for the first time.
While the 100% write-off has been made retroactive to Sept. 27, 2017, the faster write-off of equipment costs is only temporary. It is at the 100% level for expenditures between Sept. 27, 2017, and Jan. 1, 2023. After 2023 and before 2025, the amount deductible drops to 60%, with a further decrease to 40% after 2025 and to 20% after 2026. On Jan. 1, 2027, the equipment cost write-off disappears.
Section 179 expensing
The differences between bonus depreciation and the tax law’s Section 179, first-year expensing, have narrowed, with both offering 100% write-offs for both new and used property. The immediate write-off, or expensing of capital asset costs under Section 179, remains appealing because, unlike so-called bonus depreciation, the use of equipment does not have to begin with the practice.
Section 179 allows up to $1 million (up from $500,000 in 2017) of equipment expenditures to be treated as an expense and immediately deducted. The ceiling after which the Section 179 expensing allowance must be reduced dollar-for-dollar has also been increased from $2 million to $2.5 million.
In addition, improvements, including roofs, heating, ventilation, air conditioning systems, fire prevention, alarms and security systems, now qualify under the new Section 179 rules, providing another opportunity for practices that actually need equipment.
Qualified property write-offs gone
While additional improvements to the practice’s property may now qualify for the Section 179 expensing allowance, the unique write-off for the cost of improving a practice’s leased offices, clinic or other business property has been eliminated by the TCJA.
In fact, the separate definitions of qualified leasehold improvement and qualified retail improvement property have been eliminated along with the 15-year recovery period and the use of straight-line depreciation for qualified improvement property.
Today, qualified improvement property is generally depreciable over 15 years using the straight-line method and the half-year convention, whether the improvements are to property subject to a lease or placed in service more than 3 years after the date the building was first placed in service.
Interest expenses
In the past, our tax laws protected the ability of optometrists and their practices to write off the interest on loans. In an attempt to level the playing field between practices and businesses that capitalize through equity and those that borrow, the TCJA caps the interest expense deduction to 30% of the practice’s adjusted taxable income.
Exceptions exist for smaller practices to protect their ability to write off the interest on loans that help them start or expand, hire workers and increase paychecks.
Auto expenses
Automobiles or other vehicles used in the optometry practice or provided by the practice to its principals face new write-off limits for the cost of those so-called luxury automobiles as well as other personal-use property.
For passenger automobiles and light trucks placed in service after Dec. 31, 2017, where the additional first-year depreciation deduction is not claimed, the maximum amount of allowable depreciation is increased to $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year and $5,760 for the fourth and later years in the recovery period.
For passenger automobiles placed in service after 2018, these dollar limits are indexed for inflation. In addition, for those eligible for bonus first-year depreciation, the maximum first-year depreciation allowance remains at $8,000.
Similar rules apply to not only passenger automobiles, but to any property used as a means of transportation – or so-called listed property used for purposes of entertainment, recreation or amusement. Computers and peripheral equipment have been removed from the definition of listed property and are no longer subject to the increased substantiation requirements applying to listed property.
Corporate alternative minimum tax
Too many deductions and too many otherwise legitimate tax “preferences” should not, at least according to our lawmakers, mean escaping taxes.
Under pressure, lawmakers long ago created a unique 20% tax rate as part of a parallel tax system designed to limit tax benefits and to prevent large-scale tax avoidance. Under the Alternative Minimum Tax (AMT) system, incorporated practices were required to calculate both their ordinary tax and the AMT, paying whichever was higher. Fortunately, the corporate AMT has been eliminated, lowering taxes and eliminating the confusion and uncertainty that surrounded it in the past.
Like-kind exchanges, swaps, trade-ins
The tax law’s Section 1031 governing like-kind exchanges currently allow optometrists and their practices to defer the tax bill on the built-in gains in property by exchanging it for similar property. Although more of a strategy for deferring a tax bill when business assets are sold or otherwise disposed of, with multiple exchanges gains can be deferred for decades and ultimately escape taxation entirely.
Under the TCJA, like-kind exchanges will be limited to so-called “real” property (but not for real property held primarily for sale). The new tax law redefines like-kind exchanges and includes language that will limit Section 1031 exchanges to exchanges of like-kind real property. This ensures that real estate investors maintain the benefit of deferring capital gains realized on the sale of property.
Small business accounting method, simplification
Simplification of the method of accounting required to be used by the practice is a nice option to have. Businesses and professional practices with average annual gross income of less than $25 million may now use the simple cash-basis accounting method. Yes, the current $5 million threshold for corporations and those partnerships with a corporate partner is increased to $25 million, and the requirement that such operations satisfy the $25 million requirement for all prior years has been repealed.
With the cash method of accounting, an optometry practice may account for inventory as nonincidental materials and supplies. As an alternative, an optometry practice with inventories using the cash method of accounting will be able to account for its inventories using the method reflected on its financial statements or in its books and records. Also, under the new law, the average gross receipts test will now be indexed to inflation.
Rehabilitation, disabled access credits repealed
The TCJA repeals the tax credit so many optometry professionals and their practices claimed when retrofitting or fixing their premises to be handicapped friendly.
On a related note, the Disabled Access Credit that has helped make so many offices, clinics, laboratories and other business premises become Americans With Disabilities Act-compliant, has also been repealed.
Losing with net operating losses
One of the main benefits of net operating losses (NOLs) was the fact that they could be carried back to more prosperous years to create a refund of taxes paid in those earlier years to provide an immediate infusion of badly needed cash.
Today, the NOL deduction has been severely limited. The write-off is now limited to 80% of taxable income, and only in special cases will a NOL carryback be permitted. There is no limit on how far forward NOLs may be carried.
Moving into 2018
The TCJA is the largest overhaul of the tax law in more than 30 years. It offers the potential for $1.4 trillion in tax cuts with the majority of tax changes for optometric practices – but not optometric professionals – being permanent. Obviously, planning to reap the benefits and avoid potential pitfalls for every optometric professional and his or her practice’s 2018 tax bill will require the services of a qualified professional.
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- Mark E. Battersby has been reporting on news and developments in the tax and financial arenas for more than 25 years. He can be reached at MEBatt12@Earthlink.net.
Disclosure: Battersby has no relevant financial disclosures.