6 New Tax Provisions Veterinary Hospitals Should Know

Under previous tax law, income from pass-through entities (i.e., sole proprietorships, partnerships, limited liability companies, and S corporations) was taxed as ordinary income to individual owners.

Under the new tax law, owners may be permitted to deduct up to 20 percent of their “qualified business income” from pass-through entities on their individual income tax return.

Under this provision, “qualified business income” is defined as “domestic income from a pass-through entity” but does not include investment income (e.g., dividends, capital gains, and investment interest), reasonable compensation, or guaranteed payments.

In general, the pass-through deduction would be further limited to the greater of:

• 50 percent of the individual’s share of W-2 wages paid by the pass-through entity for its workforce, or
• the sum of 25 percent of the individual’s share of W-2 wages paid by the pass-through entity plus 2.5 percent of the unadjusted basis of all qualified property.

As a general rule, income resulting from a “specified service trade or business” does not qualify for the deduction for pass-through income. Examples of specified service trade or businesses include businesses engaged in the performance of services in the fields of health, consulting, law, accounting, and financial services.

However, an individual taxpayer would be exempt from this provision, as well as the W-2 limitation, if their taxable income does not exceed $315,000 for married-filing-jointly filers or $157,500 for single filers.

Businesses engaged in health services do not qualify for the deduction for pass-through income, but the IRS has yet to issue definitive guidance that makes it clear whether health services is limited to a human’s health or extends to health services provided to animals as well. If a veterinary practice is not considered a qualified business for purposes of this deduction, the individual owners of veterinary practices will not be entitled to the pass-through deduction.

Because the regulations are still being issued, we do not yet know how the “specified service business” rule will be applied to veterinary hospitals with revenue streams such as pharmacy, dietary, and ancillary products. We believe there may be planning opportunities to separate nonservice income, which would possibly allow for the 20 percent deduction related to the net income generated from nonservice sales. There will be more to come on this specific implication as we receive further clarification.

Under prior law, C corporations’ federal taxes were based on a graduated system with a top rate of 35 percent. The new tax law eliminates the graduated system and replaces it with a flat 21 percent income tax for all C corporations. Additionally, the new tax law will not have a special tax rate for personal service corporations.

For profitable hospitals structured as C corporations, the new corporate income tax rate will generally result in increased cash flow (less income tax expense). If the business interest limitation applies, these hospitals may want to consider using excess cash flow to invest in new equipment or pay down debt.

The change in corporate tax rates has raised many questions about whether C corporations should now be the entity of choice for veterinary hospitals previously structured as pass-through entities.

Under previous law, the C corporation structure generally has not been advantageous for veterinary hospitals due to double taxation of shareholder distributions/dividends. Although the new law does lower C corporation tax rates, all cash distributed to shareholders is still subject to taxation as a dividend. The double taxation will be especially burdensome for owners that are planning to sell their hospital. The gain on the sale of assets will be assessed at the corporate tax rate; then, the remaining proceeds distributed to the C corporation owners will also be taxed. Even with the new 21 percent C corporation tax, owners will be taxed on the remaining 79 percent of funds when the funds are liquidated at a potential 20 percent individual tax rate for long-term capital gains. This equates to a 37 percent overall tax rate.

A stock sale would be more favorable as owners will only be subject to a 20 percent long-term capital gain tax on the sale. However, with increased limits for both bonus and Section 179 depreciation, asset purchases have become even more appealing to potential buyers and may leave no room for stock sale negotiations.

Bonus depreciation

Hospitals will be entitled to expense 100 percent of the qualified property placed in service after Sept. 27, 2017, and before Jan. 1, 2023. Beginning Jan. 1, 2023, the amount of qualified property a business will be able to expense will decrease 20 percent per year. As a significant departure from prior law, most used property will also qualify for this 100 percent write-off.

Section 179 depreciation

Under the new law, veterinary hospitals can claim up to $1 million of Section 179 depreciation on qualifying property placed in service each year. This increased from $500,000 (indexed for inflation) under previous tax law. Additionally, the new law expands the definition of qualified property to include all qualified improvement property and certain improvements made to nonresidential real property. The new law also increases the threshold for phase-out to $2.5 million and indexes it for inflation.

Auto depreciation limits

Under the new law, depreciation rules for both Section 179 and bonus depreciation have not changed for vehicles with a gross vehicle weight of 6,000 pounds or less. If a hospital purchases a new vehicle that has a gross vehicle weight less than 6,000 pounds and the purchase price falls within the IRS guidelines of a luxury auto (passenger auto over $18,600; trucks or vans over $19,267), the annual depreciation is limited for both Section 179 and bonus depreciation.

Hospitals will continue to have the option to immediately reduce taxable income in the year new or used equipment or other qualifying capital assets are purchased. The additional inclusion of qualified improvement property and certain nonresidential building improvements under the Section 179 expensing rules could make qualifying hospital remodels more appealing given the new options to accelerate depreciation.

If a veterinary hospital is in need of a new vehicle, the owner may want to focus the search on those vehicles with a gross vehicle weight greater than 6,000 pounds. These vehicles will not be subject to annual bonus depreciation limits and can be completely written off in the year they are placed in service.

Previously, a business could deduct 50 percent of expenses incurred for entertainment, amusement, or recreation. The new law eliminates this deduction, although there are a few exceptions. This means that unless you qualify for one of the exceptions, there will be no deduction for tax purposes for these expenditures.

There are nine specific exemptions that are still deductible. Those deductible exemptions that are most applicable to veterinary hospitals include the following:

• Recreational or social activities primarily for the benefit of the employee, such as holiday parties, annual picnics, or employee outings
• Reimbursed expenses
• Expenses that are treated as compensation
• Food and beverage for employees furnished on the business premises of the taxpayer facility
• Expenses incurred by a taxpayer (i.e., hospital) which are directly related to business meetings of employees, stockholders, agents, or directors
• Expenses includible in income of persons who are not employees (such as compensation, a prize, or award under Section 74)

The law retains the current 50 percent deduction limitation on food and beverage expenses. However, effective in 2025, the law disallows the deduction for meals provided for the convenience of the employer on the employer’s business premises.

Veterinary hospitals should start separating the financial statement chart of accounts categories for meals and entertainment, which have historically been classified together. Separating these expenses will allow the categories to be easily identified and will help ensure that they get reported correctly for tax purposes.

The law also disallows deductions for expenses associated with providing qualified transportation fringe benefits to employees as well as any expense incurred in providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of business.

Businesses will no longer be able to deduct most moving expense reimbursements provided to employees, nor can employees exclude these amounts from income if reimbursed by the employer.

Hospitals that have historically offered to reimburse moving expenses in order to attract DVMs will need to report the moving expenses on the associates’ W-2 wages as compensation.

Like-kind exchange transactions under Section 1031 will be limited to real property that is not primarily held for sale. The guidelines are in effect as of Dec. 31, 2017, but the old rules may still apply if the taxpayer disposes of the old asset or received the new asset prior to year-end.

Hospital owners will no longer be able to defer taxable gains when trading in business vehicles or equipment. When budgeting for new equipment as part of a trade-in, hospital owners will need to consider the trade-in value placed on the disposed asset and the possible associated tax burden.