Big changes in state tax law begin Jan. 1 – and many companies are calling their accountants wanting to know what to do.
The biggest change for business is the elimination of taxes on S Corporations, those companies where the money passes through the company and into the hands of the owner. These companies tend to be small: sole proprietorships and partnerships.
Essentially the queries involve clients calling for confirmation that the law means “what they think the law says,” said Shawn Sullivan, senor vice president of tax service for Allen Gibbs and Houlik.
If that sounds confusing, there’s a reason. State officials last week started sending out what are known as guidance letters that attempted to clarify provisions in the legislation passed by lawmakers earlier this year.
Companies that are organized as more traditional C Corporations still have to pay state corporate income tax, and some of them want to know if they should dissolve and reform as S Corporations.
“We are going through that decision-making with virtually every one of our C corporations,” said Bob Schuster, group leader for general practice for accounting firm Kennedy and Coe.
But Schuster and other accountants say that, at this point, they don’t foresee a lot of changes.
First, the great majority of companies are already S corporations, so they will get the benefit without any changes.
Second, they say, is that federal taxes are much larger than state taxes and typically drive major decisions.
“The 800 pound gorilla is still the federal government, and we do have to talk about the fiscal cliff and broadening the tax base, but we don’t know what Washington will do,” said accountant Gary Allerheiligan. “I encourage them to wait before they make any decisions until we know what Washington will do.”
And third, there remains a lot of uncertainty surrounding whether the state can really afford to eliminate taxes on S corporations over the long term, they said.
And, they said, there is also some uncertainty surrounding whether the Legislature really will act early in the session, as promised, to correct several significant technical defects in the tax law the lawmakers approved. For instance, the law makes no reference to LLCs, even though most of those are organized as “pass through” companies.
C corporations can’t actually dissolve and reform as S corporations until Jan. 1 anyway, Allerheiligan said. The companies have the first two and a half months of the year to make a decision.
A second major issue is that contractors no longer have to pay state income taxes, but their employees do.
That may encourage some workers to see whether it is possible to be reclassified as contractors rather than employees.
That kind of change is harder than reclassifying a company, said Schuster, because the IRS has pretty strict tests on who is an employee and who is a contractor – and they can’t simply change for tax reasons.
Also, contractors have to pay increased federal taxes for Social Security and Medicare, creating a lot of drawbacks to reclassification..
It’s wonderful for existing contractors, Schuster said, but not likely to lead to large numbers of employees becoming contractors.