Tax planners looking for loopholes in new law

Uncertainty about law sets off ‘frenzy’ for some businesses.

WASHINGTON — In the hopes of paying less in taxes, several surgical centers in Louisiana are considering spinning off their parking garages into separate businesses. Eye doctors in Florida are looking at separating their eyeglasses business from their medical practices. And small and middle-size law firms around the country are pondering treating their offices as distinct real estate companies.

Tax lawyers say they are working with these types of clients to find ways to remake their operations as a result of themassive tax overhaul passed in December by Congress.

The tax law was supposed to make the tax code simpler, lowering rates while trimming tax breaks, but doctors and lawyers, among other professionals, are finding it’s something different.

The new tax law created a generous if awkwardly defined deduction available to business owners who pay their taxes through the individual tax code rather than the corporate code. This new 20 percent deduction probably will be welcome by most of these business owners, but the law specifically limited it for most high-earning owners of service firms.

That means the deduction — at least in theory — is not available to many doctors, lawyers, accountants, financial advisers and others whose primary business is providing a service. (In a feat, engineers and architects won access to the deduction in the law.) That’s leading these professions and their advisers to seek creative solutions to allow at least some of their business to get a tax deduction.

“The doctors are going berserk. The lawyers are trying to figure out everything they can. Clients are calling right and left. It’s a planning frenzy,” said Bill Elliott, a Dallas tax expert and former chair of the state bar of Texas.

The urgent tax planning underscores the perils of a sprawling law that was drafted quickly, altered late in the process and took effect within days of passage — giving the Internal Revenue Service little time to work on the regulatory minutiae needed to make sure the law works the way its authors intended.

And if companies are broadly able to get in on a tax break that wasn’t intended for them, it would mean an unexpected cut to government revenue that further expands the law’s impact on the ballooning federal government’s deficit. The law as written is projected by the Joint Committee on Taxation to raise the deficit by $1 trillion over the next decade.

Millions of American businesses pay taxes through the individual tax code, known in tax parlance as “pass-through” businesses. They’ve historically done that so they could pay taxes below the 35 percent corporate tax rate, which was reduced to 21 percent in the December tax law.

To make sure these passthrough businesses also got relief, the tax law created a new deduction for them on their business income. The deduction was intended to exclude affluent doctors, lawyers, and other “service” industries that may be unsympathetic constituencies for a tax break, and the law’s Republican drafters constructed rules meant to ensure they were excluded.

But those rules may be harder to enforce than had been envisioned. Many of these service industries are exploring forming separate companies, controlled by the same owners, that qualify for the deduction under the law — even if the original business does not.

The Internal Revenue Service still needs to issue regulations governing how the tax deduction will work, one of a slew of issues with the new law that regulators are rushing to resolve. The deduction is at the top of a list of 39 different unresolved tax problems for which the American Institute of CPAs, the nation’s leading association of accountants, has asked for “immediate guidance.”

It’s not clear what the IRS will do. Speaking to reporters in February, acting IRS commissioner David J. Kautter said that the agency has “a lot of resources” currently devoted to studying the potential need for further guidance about the new deduction.

“My guess is we will not have proposed [regulations] for that area until late summer or early fall. We may issue something before that,” Kautter said, adding that a “final decision” had not been made.

The new deduction was added at the insistence of Sens. Ron Johnson, R-Wis., and Steve Daines, R-Mont., two former business executives who maintained it would not be fair to slash the corporate tax rate without also providing tax relief to the millions of American businesses formed as passthroughs.

A 20 percent deduction is permitted to owners making less than a certain amount ($157,000 for individuals, or $315,000 for couples filing jointly). For those making more, the new deduction is either not available or pared back for businesses characterized as providing services. The deduction was broadened at the last minute in a way that makes it easier for real estate companies to claim.

Tax consultants are searching for ways to try to claim the deduction anyway.

“It’s a big thing: Everyone is talking about it like it’s tiddlywinks, like it’s Legos, like it’s basic 101 stuff,” said Harvey Bezozi, a tax consultant based in Boca Raton, Florida. “Trying to get this is a no-brainer.”

One idea being floated is to split up the businesses of doctors such as optometrists and chiropractors, separating the medical services they provide from the products they sell patients, Bezozi said. The optometrist could give eye exams under one medical entity, and then have a separate corporate structure for sales of glasses and contacts lenses that qualifies for the 20 percent deduction.

“You’re trying to convert ordinary income rates by putting it into another box and calling that box ‘real estate.’ It has all the potential in the world for abuse,” said Elliott, the tax expert in Dallas.

The biggest private law firms in New York City and Washington are unlikely to try splitting off separate real estate companies, in part because doing so would create a raft of governance questions too difficult for big organizations to reconcile, several tax experts said.

Republicans say the new provision will encourage business investment and job growth, as the effective tax cut gives some owners more capital to spend in the sectors targeted by the deduction. They made similar claims about the benefits of the corporate tax cut.

But critics say the rules around the deduction make little sense, and that the new rules will be easily circumvented.