What the Tax Cut and Jobs Act means for architects
With tax season now upon us, it’s important to revisit the 2017 Tax Cut and Jobs Act, as it impacts every architecture firm in the country. Firm owners and sole proprietors will benefit in major ways, as long as you keep up to date and seek proper consultation. Here are some key things you need to know:
What are the facts?
If your firm is organized as a C-Corporation—an entity where the owners and shareholders are taxed separately from the entity—you now will enjoy a top corporate rate reduction from 35 percent to 21 percent under the new law. On the other hand, “pass-through” entities such as S-Corps, partnerships, LLCs, and sole proprietorships that are taxed at the individual level, are now subject to new lower individual tax rates with a 20 percent deduction on “Qualified Business Income” (QBI).
Congress established the new 20 percent deduction for QBI (other than by “Specified Service Businesses,” which are subject to strict income limitations to take the new deduction) in new IRC Section 199A in an attempt to maintain parity and provide a substantial tax cut for those business entities paying individual rates with the cut to the corporate rate being granted to corporations. So, the Act reduced the top individual rate on ordinary income from 39.6 percent to 37 percent, and the enactment of Section 199A further reduced the effective top rate on income earned by owners of sole proprietorships, S corporations and partnerships to 29.6 percent.
What action should I take?
The new deduction does come with some limitations on what qualifies as QBI for higher income earners, so AIA recommends that you consult with a tax professional on the implications of the new law to your corporate or individual tax liability.
For larger firms or high-income earning individuals—those that earn above $207,500 and married taxpayers earning above $415,000—the available QBI deduction will be the lesser of the following formulas:
- 20 percent of “Qualified Business Income”; or the greater of
- 50 percent ; of the W-2 wages paid from the qualified business; or
- 25 percent of the W-2 wages paid from the qualified business, plus 2.5 percent of the unadjusted basis of the qualified property
How does this impact architects?
“Specified Service Businesses” are defined as those in which the principal asset is the reputation or skill of one or more of its owners. Typical examples of such occupations are those that provide a personal service, such as consultants, lawyers, accountants, investment brokers, performing artists, doctors, and professional athletes. While architects could fall into that category, AIA members and the AIA Federal Relations team worked hard to encourage amendments to the act that positively benefit the profession.
Thanks to their efforts, architects and engineers were specifically excluded from the “Specified Service Businesses” definition and will be allowed to take the 20 percent deduction on qualified business income, subject to the limitations discussed above. This is a huge win for architects, especially since AIA surveys indicate that more than 57 percent of architecture firms are organized as “pass-through” entities.
One more important aspect of the tax law is its retention of the 20 percent Historic Tax Credit (HTC) for historic structures. The initial House-passed bill would have completely eliminated this important credit as well as the 10 percent credit for pre-1936 buildings. After lobbying by AIA and other organizations, the final legislation generally follows the Senate bill with respect to HTCs. The 10 percent credit for pre-1936 buildings no longer exists and the 20 percent credit for certified historic structures remains but must now be claimed over a five-year period.
On January 18, 2019, the IRS issued final regulations providing more detail and clarity on how they intend to implement and enforce the new law. Those regulations can be found on the IRS website.