Small Business or Syndicate? The Answer Might Surprise You

Owners of businesses who have investors might be in for a rude awakening when it comes to the new tax laws. A small business, defined as a business with less than $25 million in gross receipts, is generally eligible for a range of tax breaks. But you might be surprised to find out that your small business is actually a syndicate—depriving you of some of these benefits under the Tax Cuts and Jobs Act (TCJA).

Most small business owners assume that as long as their annual gross receipts don’t exceed $25 million, their company is considered a small business. However, if the small business has losses, the IRS also considers who gets the benefit of the losses.

If your partnership or S corporation allocates 35% or more of its losses to limited partners and limited entrepreneurs, your company is actually considered a syndicate (i.e., a tax shelter) and not a small business. And the tax picture for a syndicate is different from that of a small business.

We’ll discuss two of these differences here.

Exemption from the Business Interest Deduction Limitation

The TCJA has imposed a limit of 30% of your annual net earnings (before interest) on the deduction you can take for business interest expenses. Small businesses are exempt from that limit; syndicates must apply it.

Let’s illustrate this with an example:

SMALL BUSINESS

• Earns $10,000 in a year (after all expenses except for interest the business pays on loans)
• Pays $4,000 in loan interest
• Business owner can deduct the $4,000 amount from the business’ tax return for that year

SYNDICATE

• Earns $10,000 in a year (after all expenses except for interest the business pays on loans)
• Pays $4,000 in loan interest
• Business owner can only deduct $3,000 (30% of annual earnings) from the business’ tax return for that year

So a syndicate misses out on $1,000 worth of deductions in the current year because it is not considered a small business.

Use of Cash Accounting Method

Smaller businesses often don’t need complex accounting, which is why cash accounting works so well for them. In cash accounting, expenses directly related to delivering your product or service are recognized at the time the expenses are paid. There’s no need to take into account other elements such as prepaid or unpaid  expenses and prepaid or deferred sales (which you must consider in accrual accounting, the required method for larger and more complex entities).

Because cash accounting is simpler, it requires less time to learn and less expertise to maintain your financial situation. This makes it an ideal choice for small businesses that don’t have the resources for anything more complicated or when cash from customers is not received immediately.

The TCJA stipulates that small businesses can use the cash accounting method. However, if your company is classified as a syndicate, you must use the accrual accounting method.

How Do I Know if My Company Has Limited Partners/Entrepreneurs?

To quote an oft-used phrase… it’s complicated. In theory, a limited partner or entrepreneur has minimal involvement or participation with the operations of your business. But exactly what those guidelines are is open to judgment and can vary greatly.

This is why it’s critical to speak with James Moore’s real estate CPAs about your entity’s business classification. By taking a careful look at your unique operations and structure, we’ll make sense of these and other guidelines to determine whether your small business is actually a syndicate. This in turn will help you get the most out of your business return (and stay IRS compliant in the process).

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