On December 22, 2017, the “Tax Cuts and Jobs Act” (“TCJA”) was signed into law. This was comprehensive tax legislation—the first in over 30 years. The bill was designed to promote economic growth and create jobs; help make U.S. companies more competitive with the rest of the world; provide middle class tax relief; and simplify the tax law. The tax reform bill received much attention as it moved through Congress and continued this publicity after it was enacted. Within days of its passage, businesses across the country announced that they would be paying bonuses to their employees in response to the bill. From several hundred dollars to several thousand dollars, businesses were offering bonuses, in part, due to the tax cut they would receive from the lower tax rates included in this legislation.
What can companies do and communicate to their employees in response to the tax bill? Should a company fall in step with highly publicized businesses and pay bonuses? Or, should a company hire more employees, or perhaps reinvest into more equipment? Are there other options? Further, what (if anything) should the company discuss with its employees? This article addresses some of these questions and issues.
Overview of the Tax Bill
The TCJA was one of the most significant pieces of tax legislation in a generation. There were substantive changes that will impact businesses, regardless of their size, in all industries. A centerpiece of the TCJA was a reduction in the tax rate for corporations (“C Corporations”) from 35% down to 21%. This lower tax rate for businesses first applies beginning in 2018. Further, pass-through businesses (Partnerships, S Corporations, and Sole Proprietorships) will also see a reduction in their tax liabilities, although this tax change for pass-through businesses is much more complicated and there are still many uncertainties. Individual taxpayers will also see some tax rate reductions.
In addition, the TCJA offered some expanded CapEx deductions of 100% for bonus depreciation and higher Section 179 amounts. For those businesses with foreign operations or holdings, there were wholesale changes with international taxes, some of which apply here in 2018. (Please click here for Sikich articles on a TCJA overview and another on international changes.)
Projected Tax Impact to the Company
It is important for a business to determine the impact of tax reform. Before a business can look at paying bonuses to its employees or investing in anything else, it needs to assess what its tax position will be once the new tax law takes full effect. While the lower tax rates noted above should provide some savings for most businesses, this needs to be modeled out. In addition, businesses should evaluate whether there are any tax planning strategies they can implement that could enhance their savings from tax reform even more. This might include perhaps changing entity status from an S Corporation to a C Corporation to take advantage of the new lower tax rates, or re-structuring their business for the new 20% deduction for pass-throughs. We can assist businesses in modeling out these tax changes, as well as in identifying any tax planning opportunities.
Projected Tax Impact to the Company’s Employees
As indicated above, not only will a business likely see tax savings from the TCJA, but a business’ employees should also probably realize individual tax savings. Again, one of the stated themes of the TCJA was middle class tax relief. There were a number of tax provisions in the bill impacting individuals, with the major changes being a reduction in the individual tax rates and a modification in the tax treatment of itemized deductions. Several itemized deductions were scaled back or eliminated, but the TCJA also made corresponding changes to the standard deduction by nearly doubling it to $24,000 in 2018 for a married couple filing jointly and to $12,000 for a single taxpayer. In addition, the personal and dependent exemption was eliminated for 2018, but the child tax credit was doubled from $1,000 to $2,000.
Most individual taxpayers should see some tax savings under TCJA, but each individual situation is different. Here are two examples illustrating the tax impact of TCJA in 2018:
- Example 1. Brad earns $60,000 in his job and has no other sources of income. He files as a single taxpayer; has no dependents; claims the standard deduction; and has no other tax credits or special deductions. In this case, Brad’s federal tax in 2017 would be $8,139, but assuming the same income and facts as for 2017, his tax in 2018 would drop to $6,500—a $1,639 tax reduction (roughly 20%)—as a result of the TCJA.
- Example 2. Fred and Ethyl earn $110,000 of combined income in their jobs and have no other sources if income. They use married filing jointly status; have two young dependent children aged three and five; claim the standard deduction; and have no other tax credits or special deductions. In this situation, Fred and Ethyl would have a 2017 federal tax of $9,753, but again assuming the same income and facts as in 2017, this tax would drop to $6,799 in 2018—a $2,954 tax savings (approximately 30%)—as a result of the TCJA.
What Companies and Other Employers Can Do Regarding the Anticipated Employee Tax Savings from the TCJA in 2018
Employees may see similar tax savings in 2018 (as shown in the examples above) as a result of the TCJA. Rather than wait until they file their 2018 individual tax return next April to grasp these tax savings, the employee may want to adjust their tax withholding now to realize these savings with each paycheck during 2018. They can do this by filing a revised Form W-4 and providing this to their appropriate personnel in the company’s payroll department. Employers can make employees aware of the possible tax savings in 2018 and give them the opportunity to file a new Form W-4. This allows them the opportunity to gain these tax savings earlier in 2018 and not wait until the end of the year.
The IRS has recently issued a Form W-4 calculator which can assist employees in determining what changes to make in their Form W-4 (please click here for this Form W-4 calculator from the IRS Website). While businesses and employers can inform employees of the possible tax savings in 2018 and the opportunity to file a revised Form W-4, employees should be encouraged to consult with their tax advisors for the impact in their particular situation.
Options a Company Might Consider with its TCJA Tax Savings
As noted above and publicized in the news, companies can pay bonuses or higher wages to their employees with their TCJA tax savings. But there are other compensation alternatives that might also be worth exploring. For instance, making additional contributions to a company’s 401(k) or other qualified retirement plan. This could provide added retirement benefits for employees. A business could also establish a non-qualified deferred compensation plan for certain key individuals.
In addition, there is a new stock options program that was added by TCJA that is available to all employees (not just certain key employees) and it provides some tax savings and deferral features for covered employees. This new program has some complications and IRS guidance is needed. A combination of these compensation tools could be used, say paying bonuses and making added 401(k) contributions.
Companies could also look to grow their business with their TCJA savings. This could include hiring new employees and also buying new machinery and equipment for the business. Or, a company could look to expand by making an acquisition or moving into new geographic areas. Another approach a company could take in trying to add market share might be cutting prices on some of its products with the price reductions funded by the TCJA tax savings.
Companies could also look to make financial oriented moves with their tax savings. This could include paying down outstanding debt, which should be analyzed in light of new limitations from the TCJA on deducting interest expense. A company could also direct some of their tax savings in redeeming out some owners, along with evaluating perhaps higher distributions to its stakeholders.
So, there are a number of options as to what a company can do with its projected TCJA tax savings. It could focus its efforts on one of these items, or a combination of several of these.
Also, What (if anything) Should Companies Discuss with their Employees?
This is something the ownership and management of each company needs to consider. They should determine what the impact of the TCJA will be on their business and what they plan to do with the tax savings. Once they have made these decisions, they can then determine whether or not they will share these findings with their employees. Businesses generally have a good idea on how news will be received by their employees. But since many businesses have been up front in recent weeks with their plans on paying out bonuses, other businesses may now feel they owe it to their employees to at least address what they plan to do and why. Many employees see and hear what is going around them and are asking how this tax bill may impact them not only individually, but how the company they work for will be impacted.
If the company decides to share the news with employees, they next need to determine how best to present the news. Should it be a company-wide meeting? Or, a video message from the company’s president or other top management? Perhaps a well-written company email or memo would suffice? There are different approaches and styles to consider. Remember, even if management decides not to share what its plans are for its TCJA savings, the company can at least address the likely tax savings for its workforce and the need for all employees to review and perhaps adjust their W-4 withholding to realize some tax savings earlier. Further, a company might approach these tax reform efforts in stages: (1) inform employees of the tax changes and opportunities to evaluate their withholding in their Form W-4; and (2) perhaps later what the company intends to do with its tax savings. There are many options for a company to consider.
Taxes are top of mind for everyone this time of year. Most of the tax changes in the TCJA first take effect for 2018, and businesses and individuals should realize some tax savings. Company management needs to be intentional about determining the anticipated impact of tax relief on their business and what they plan on doing with these savings. Once they have completed this process, they should decide what to share, if anything, with their employees. Whether it’s a bonus; a higher 401(k) contribution; a new major CapEx purchase, or the hiring of several new workers, employees are curious on these matters. As you move through this process, we can help. Please contact your Sikich advisor to assist in evaluating the impact of the TCJA, what to do with these savings, and how to share this message with your employees.