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Much has been published and much is still to be published on the impact of the new federal tax law recently made effective generally as of January 1, 2018. Based on our experiences with the operation, management and sale of manufacturers’ rep agencies, here are some thoughts on the new tax laws.

S vs. C Corporation

For a number of years, the S corporation has been the entity of choice for manufacturers’ representatives because S corporations themselves generally are not taxed. Instead, the income or loss of an S corporation rep agency is taxed at the shareholder level. In addition, profit distributions from S corporations are generally not subject to FICA and Medicare taxes, making S corporations attractive to many reps.

Under the new law and very rough terms, there will likely be about a four percent long-range income tax advantage to S corporations, as opposed to C corporations. This is because the new law provides a 20 percent tax deduction in many cases for S corporation distributions. This treatment does come at the limitation of state income tax deductions, for both real estate and state income taxes of $10,000.

With respect to C corporations, the income tax rate has been reduced to 21 percent for federal purposes. While this rate appears to be attractive, a second or double tax rate will be applied on the distribution of these taxed earnings from the C corporation, raising the effective rate to about four percent greater than the net effective tax rate for S corporations.

Reps should be careful to check with their tax financial advisors on their individual situations. There are cases in which one structure or the other may be beneficial. However, some caution should be undertaken with respect to any changes. Essentially, a taxpayer needs to stick with the same entity whether C or S corporation for five years once an election is made. Reversing the process sooner than the five-year period is difficult, if not impossible.

Reps as Professionals

The new law contains some restrictions that apply to attorneys, accountants, engineers, and other professionals such that the benefits of the 20 percent deduction for S distributions will not be available once income exceeds $207,500 for single filers, and $415,000 for married filing jointly. It is possible that reps will be included in these professional categories or that the regulations will be silent with respect to reps. Historically, tax regulation writers have not necessarily had manufacturers’ reps at the forefront of their thinking in the writing of the regulations. As of this writing, we are fairly confident that many reps will be able to receive this built-in deduction. Technically, reps have no customers only principals that they provide soliciting, expediting and facilitation of sales services. To this extent, it appears that the professional limitations might not apply to reps especially for agencies with multiple employee representatives.

S and C Corporations

There may be instances where having both an S corporation and a C corporation might be very well viable in the manufacturers’ rep world. As an example, an S corporation might be used as discussed above for a conventional agency. However, a C corporation might be used for risky product lines or buy-sell/dealership type activities. In this manner, the benefits of both types of companies might be achieved. Specifically, the flow-through would be available for agency-type activities and the C corporation could be used to storehouse capital, at lower effective tax rates, over a long-range basis. Also, keep in mind that state income taxes will be deductible for C corporations, but not S corporations.

No Entertainment Deductions

The new law disallows almost all entertainment deductions. This means that as of January 1, 2018, the somewhat traditional entertainment expenses for professional sporting events, rounds of golf, concerts, and similar expenses will not be deductible. A blurred line will exist with respect to meals and whether or not those meals are part of business conversations that are tied into entertainment events. Again, the regulations will hopefully provide some clarification.

Capital Equipment

The new tax law provides major incentives for companies undertaking significant capital equipment expenditures. Capital equipment reps should be up on and understand that much in the way of capital equipment expenditures of up to $1 million could be fully tax deductible to the acquirer once the equipment is placed in service. In addition bonus depreciation can provide virtually unlimited tax deductions for capital equipment purchases in many cases.

Care needs to be taken to watch and pay attention to be sure this deduction is taken in the year in which the buyer (acquirer) is in a maximum tax bracket otherwise there may be instances where spreading the depreciation deduction over a number of years could be more beneficial. Spreading the deduction may be beneficial if, for example, tax rates or the taxpayer’s bracket rises in future years. The point here is that these tax deductions may provide an incentive for reps to be able to sell such equipment on behalf of their suppliers. This is exactly the legislation’s intended stimulus.

Conclusion

Very big picture, it still looks like S corporations should be the entity of choice generally for manufacturers’ reps. In each situation, reps should check with their advisors as to the particular configuration set up for their own businesses. Reps should also be mindful that such entertainment expenses will not be deductible, generally. Finally, there may be some significant incentives to spur sales in the capital equipment industry.

MANA welcomes your comments on this article. Write to us at [email protected].