The assumption in my household all year was that the Republican tax cut bill was meant to really benefit people richer than we are, in other states, and that at best we would break even.
Then came the final bill, and while our assumption turned out to be mostly correct, it appears our household will do better than we had once thought. That’s because my wife’s business is commercial real estate.
No industry made out better. “The Big Winner of The Tax Bill: Commercial Real Estate,” read the headline over an article on the investment website Seeking Alpha.
Being one of the favored taxpayers in a system that will remain as hopelessly complex as ever is nothing to feel great about, but it sure beats being one of the losers.
Yet figuring out exactly how the system will work next year is far from easy. The tax reformers in Washington, as it turned out, didn’t even really try to make most of the tax system simpler. The result is a downloadable file totaling 1,097 pages.
Politics aside, it would have been easy to make a simple system. Start with just taxing all income the same, whether from a business, as wages or from selling an asset. That would eliminate much of the need for rules, plus take away the incentive for taxpayers to come up with ever more creative ways to avoid taxes by making sure any money they get comes in a way that’s taxed the least.
It would also be good to get rid of many if not most of the tax credits, deductions and other special provisions that favor one activity over another.
The tax bill didn’t do that, of course. Corporations will pay one rate, individuals will pay a different set of rates and then a vast new field of tax complexity was introduced for business owners taxed as individuals. There will be different amounts of tax paid even by business owners more or less in the same business and earning the same amount of money.
Even after reading twice through the final congressional committee report’s discussion of taxing so-called pass-through businesses and talking to an accountant and senior tax lawyer, there’s no way to easily explain how this could have happened.
A pass-through is a business entity, usually a limited liability company or partnership, where the tax liability gets passed through to individual owners. It’s often thought of as the heartland of small business, but lots of big companies get set up this way, too. One study found that only about half of taxpayers using this approach seem to be part of a small businesses, generating just a fraction of business income. Yet to Congress, being a pass-through owner sure beats earning wages, as owners will now get a big deduction right off the top.
An income of $100,000 earned by working hard at a salaried job will be taxed as $100,000. Income of $100,000 flowing through to a partner in Main Street Building, LLC, may be taxed as $80,000. Sorry if that doesn’t seem fair.
There were other goodies in the bill for commercial real estate, too, like still allowing owners to trade in and out of buildings and postpone any capital gains.
Congressional negotiators wanted taxes cut for business owners but seemed wary of giving well-paid taxpayers a chance to game the system by making themselves into business partnerships to claim a big deduction. They had good reason to worry about that.
Not that long ago, Kansas decided business owners shouldn’t pay state income taxes. No surprise, the number of pass-through entities there surged 75 percent in just a couple of years. A burst of entrepreneurship? No, just a burst of tax avoidance.
What Congress finally arrived at is a 20 percent deduction on taxable income for business owners, tying it to a formula based in part on wages paid and in part on the partnership owning certain kinds of property, like a building.
It also decided to create a phaseout of this deduction for lawyers, consultants, doctors, money managers and other professions but not until hitting $315,000 in taxable income for joint filers. By the way, that’s taxable income, after taking the standard deduction or a slew of itemized deductions.
For a reason that passes all understanding, architects and engineers were specifically carved out from that limit.
So imagine a real estate developer coming up with an idea for a little-used corner of a shopping center parking lot. The developer will need some help from companies all taxed as pass-throughs, starting with an architect and an engineer.
There are going to be questions from City Hall about traffic, so the developer also hires a traffic engineer who makes some money on the assignment. Is this engineering? Does this income get the biggest deduction, too?
Then there’s the parking consultant. Too bad he’s just a lowly consultant, who could easily end up getting less after-tax pay than the architect. Of course, he may get more after-tax pay than a consultant working for a salary at another company.
If you are wondering how different tax treatment on the income earned for similar work on the same project could be good tax policy, it’s not. It’s not even close to good policy.
Beneficiaries of special treatment didn’t see it that way, of course. Here’s what the American Institute of Architects had to say about the bill that was passed: “The AIA lobbied hard and successfully to improve this bill, and to ensure that architects continue to be major job creators in the American economy.”
Maybe the parking consultants simply got themselves out-lobbied by the architects.
It’s easy to think of things prosperous parking consultants could do to try to cut their taxes. They could even try calling what they do engineering, filing for the full deduction and then hoping for the best.
All of which brings me to the single best idea I have for 2018. It’s not tax advice but a suggestion for a new hobby, one that should offer plenty of chances to meet other enthusiasts in a big and growing community.
And it could be fun, too, getting together at the club or coffee shop and swapping all the clever ways to game the new tax code.
Lee Schafer • 612-673-4302