The Tax Cuts and Jobs Act has the potential to make a big impact for small businesses, but you’ll need to sharpen your pencil to take advantage of the changes.
The big headline from the bill was the reduction of the corporate tax rate from a maximum of 35 percent to a flat 21 percent. This tax applies to businesses that are structured as C- corporations, which includes almost all major companies and many smaller ones. Much different, and much more complicated, changes apply to small businesses that are structured as “pass-through” business entities.
Deduction on pass-through income
Most small businesses choose to structure themselves as either a limited liability company (LLC), a partnership, a sole proprietorship, or an S- corporation, entities that do not pay the corporate income tax. Instead, the business’s income is “passed through” to the business owners and is subject to individual tax rates, which run as high as 37 percent under the new tax law. This creates a potentially sizeable tax burden when compared to the 21 percent corporate tax rate.
In order to address this disparity in tax rates, the new law provides individuals with a 20 percent deduction against pass-through business income. The new write-off is a “between the lines” deduction, meaning it is neither an exemption lowering adjusted gross income nor a deduction that requires a taxpayer to itemize.
There are income caps on the new 20 percent deduction: it begins to phase out when the taxpayer’s total taxable income reaches $157,500 for single filers or $315,000 for married couples filing jointly. It disappears entirely when taxable income is more than $207,500 and $415,000, respectively.
The type of small business is important, too. Different rules with regards to limits apply to attorneys, healthcare providers, and several other businesses where the core of the enterprise is based on the owner’s services or reputation.
New depreciation rules
The new legislation also alters some of the long-term depreciation rules and attempts to streamline the bonus depreciation sections. Depreciation, however, remains complicated and, as Tony Nitti wrote for Forbes, requires the taxpayer “to layer pieces of new law onto an already exceedingly complicated body of provisions – Sections 168(e), 168(g), 168(k), 280F and 179 to name a few – that interact with one another in ways that are hard to predict and even harder to understand.” A tax attorney can help sort through the confusion.
Disappearing business deductions
While much of the new tax law benefits small businesses, there are some standout negatives, particularly in the area of business deductions. Deductions for entertainment expenses, some employee meals, reimbursement of employee commuting or transit expenses are limited or eliminated entirely. For example, small businesses will only be allowed to deduct 50 percent of the cost of employee meals provided on or near the work site, and the deduction for reimbursing employees’ commuting costs are gone completely.
What happens next
The IRS continues to issue guidance on the new law as their analysis and insight become more refined. Small business owners should keep an eye on the news and, in the meantime, start working with their tax professional on a plan for their 2018 return.