Critical Questions about Tax Reform
The Tax Cuts & Jobs Act (TCJA) will impact most, if not all, pharmacy entities and their owners. However, as of this writing, we do not know how many areas of this law will be implemented and as a result, how they will specifically impact the pharmacy owner. Below are the three areas of the law that we are watching closely.
1. Cash Method Accounting. In the tax years prior to 2018, with a few exceptions, pharmacies were required to report using the accrual basis of accounting on their tax returns. The accrual basis reports revenues and expenses when each is incurred. For example, an adjudicated script is a third-party receivable and although you have not received the money, the IRS categorizes this as income under the accrual basis. The same holds true for expenses, if a plumber repairs the sink in December but you pay the vendor in January, the expense is taken in December. The accrual accounting method is ideal for the pharmacy entity for financial statement purposes as it properly reflects income, expenses and provides the best financial information for effective management.
Under the TCJA, the IRS has modified the accrual basis requirements. Larger pharmacy entities and controlled pharmacy groups may still be required to report using the accrual method, but a pharmacy owner with an average size pharmacy is now allowed to report on the cash basis. This is an important tax planning opportunity for an accrual basis pharmacy which could lead to some large adjustments in the 2018 tax year. The question is how should those adjustments be calculated, adjusted and reported on the IRS Form 3115 Change in Accounting Method? Further, how will inventory be treated in the months ahead? We expect this area to create considerable discussion in the industry including by the users of the pharmacy financial information such as banks.
2. Section 199A. Section 199 applied to many compounding pharmacies; this was repealed as of 2018 and replaced with Section 199A. Section 199A allows a deduction of up to 20% for pass-through qualified business income. This area of the law was implemented to help the pass-through business owners (S Corp, Partnership, Sole Proprietor, etc.) reduce their tax rates closer to the C Corporation flat rate of 21%. The deduction applies to a business owner’s personal tax return and is based on taxable income, not adjusted gross income.
We do not yet know if Section 199A will allow pharmacies to take the deduction. The legislation excludes any “health services” income from the 199A deduction. While the term “health services” is overly broad, we believe that this exclusion will not include retail pharmacies that resell prescription drugs.
3. Business Meals. Another area which remains unclear concerns the deductibility of business meals. This area is very contentious because it affects almost every industry. Before tax reform, business meals could generally be written off at 50%, with the proper documentation. This could include a dinner out with an important vendor to discuss a key contract.
Tax reform may have a big impact dependent upon on how this area of the law is interpreted. Currently there are two opinions in the tax industry concerning the interpretation of the law. One opinion states that these types of business meals are still 50% deductible. The other opinion considers these meals “entertainment” and therefor nondeductible. Should the IRS issue guidance stating these types of meals are not deductible, look for major push back from taxpayers. For now, we suggest a new account to track these types of expenses to allow for an easy adjustment once we have clear direction concerning the issue.
These three points will be major planning areas for 2018. We are expecting some updates in the summer of 2018. As soon as we learn more, look to Sykes & Company, PA to provide additional guidance for you and your pharmacy.
Scotty Sykes, CPA, CGMA 252-632-0026