For small firms, tax reform brings advocacy wins with undefined benefits

US Capitol at dusk - Tax reform and small firms

The Tax Cuts and Jobs Act of 2017 will allow small firms to be taxed at lower individual rates—but for some, that’s not the whole picture

In December of 2017, the Republican-led Congress passed the Tax Cuts and Jobs Act of 2017. The sweeping reform bill pledged to ease the tax burden on individuals and corporations, slashing the corporate tax rate from 35 to 21 percent while adding an estimated $1.5 trillion in spending deficits over the next 10 years.

The final version of the bill, as signed into law by President Trump, offered a reprieve from what many owners of small to midsized architecture firms feared would be the result of the legislation: They would no longer be able to take advantage of the so-called “pass-through” provision, which exempts businesses such as sole proprietorships, partnerships, and S-corporations from being taxed at corporate rates. Instead, the tax rate “passes through” to the owner, who is taxed at an individual rate. The initial House and Senate bills prevented architecture firms not organized as corporations from taking advantage of this provision, grouping them with service industries like medical and law practices.

Thanks to lobbying by AIA and its members, the final version of the bill allowed smaller firms to take advantage of individual tax rates, which are lower under the new legislation, while taking an additional 20 percent deduction for qualified business income. “We were able to make the case that architects and engineers are a little bit different from doctors and lawyers,” says David Pore, a policy advisor with the Hance Scarborough law firm who worked with AIA’s government affairs team on lobbying efforts ahead of the December passage of the bill. “There is some capital investment; there is benefit to incentivizing growth and hiring of folks.”

As the legislation went through Congress, the Institute worked to improve the outcome for architects without formally taking a position for or against tax reform, aware that any reform of the tax code would inevitably affect architecture firms in different ways. Indeed, many architects see the final bill as an advocacy win but are still waiting to see how the tangible results shake out for their own firms. The tax liability for many firm owners whose companies are taxed at individual rates used to be closely tied to individual deductions and credits. With all personal exemptions eliminated as part of the Tax Cuts and Jobs Act to balance out other changes, some firm owners may not be able to take as large a deduction going forward.

Russell Davidson, FAIA, owner of KG+D Architects in Mount Kisco, New York, and 2016 AIA president, thinks the profession avoided a worst-case scenario—being taxed at the corporate rate—with the passage of the final bill but that benefits for the immediate future may be negligible.

“This new law incentivizes people to take lower salaries, and to take a portion of their profit each paycheck or quarterly to lower their tax burden,” he says. Davidson also isn’t thrilled with the $10,000 cap on the state and local tax deduction (SALT) since, as a New York firm, his property taxes are some of the highest in the country.

“If there wasn’t the SALT deduction problem, it would have a much bigger impact on me, personally, and probably on our firm,” he says. “The fact is that it just made me move income from Category A to Category B, and at the end of the day I probably will end up paying more taxes. There are some areas of the country where I’m sure that’s not true.

“It’s certainly a positive thing, from an advocacy point of view,” he continues, “and it’s fantastic to get the pass-through provision in the new tax law—but [the benefits are] going to be highly individualized based on where you are.”

Good for business in the long run?

Rob Walker, 2016 chair of AIA’s Small Firm Exchange and owner of Rob Walker Architects in Birmingham, Alabama—which typically employs between three and five people—sees the benefit of a rule included in the legislation that allows businesses to take a deduction for equipment that will depreciate over time.

“If you bought computers or software, for example, you’re able to actually realize that deduction that first year, rather than some incremental phasing,” Walker says. “For a small business, it’s a larger percentage of what you spend money on than probably otherwise.”

Walker is hopeful that the new tax bill will let him save money by taking advantage of the 20 percent deduction and lower individual rate, thereby allowing him to pour the excess back into his business—but he won’t know the full impact until he files his 2018 tax returns.

Chyanne Husar, AIA, founder of husARchitecture and this year’s AIA Small Firm Exchange chair, says that while she is still assessing the legislation’s impact on her firm—which is organized as an S-corporation—she thinks that the net result of the new tax legislation, especially for smaller architecture firms that work or subcontract on public works projects, will be negative. She also takes issue with the funding cuts to public entities like the Chicago Housing Authority, with which her firm frequently works, due to the current administration’s spending priorities.

“My overall sense is that this tax bill is not good for reasons beyond how it impacts my company,” Husar says. “Even if it has a perceived benefit to me right now, inherently I am not trusting that this tax bill is going to be good for business in the long run.”

A final win

While the potential pitfalls and benefits of the final piece of legislation remain unclear, one indisputable triumph came in the form of the preservation of the Historic Tax Credit. This provision allows rehabilitation projects focusing on buildings listed on the National Register of Historic Places to take a 20 percent deduction on property taxes in the first year. Although the initial House bill proposed eliminating this credit, the final version spread the same 20 percent credit over five years.

Permitting owners of non-corporate firms like Husar to take advantage of the pass-through provision can be seen as a small victory, despite the uncertainty of the results it will render.

“As small firms,” Husar says, “it’s nice to have something to celebrate, or at least appreciate, out of this.”

Katherine Flynn is a writer/editor at AIA focusing on industry trends and emerging ideas.

Image credits

US Capitol at dusk - Tax reform and small firms

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