For the first time in more than three decades, Congress passed a major tax reform featuring sweeping changes.
The Tax Cuts and Jobs Act aims to spur economic growth across the United States by adjusting tax structures for small businesses and corporations. Some of those changes may directly affect your business.
As with any tax reform, there are pros and cons, but the overall consensus from business owners I spoke to was a feeling that the tax reform could be a positive for many businesses.
"I was skeptical about the tax reform initially, but I've found that it's a boon for my business," says Paul Bromen, owner of mattress review site Upon A Mattress. "The tax savings and opportunity to keep more of the site's earnings has enabled me to hire a full-time writer for the website."
Improved Tax Situation for Many Businesses
The consensus coming out of the Small Business Administration is that the Tax Reform will benefit businesses. In an official statement, SBA Administrator Linda McMahon, commented, "I am confident that small business owners across the country will see increased opportunities for the development and expansion of their businesses in the upcoming years as a result of this important legislation."
How much of a tax break your company will get depends on whether you are incorporated. Those businesses that are incorporated will have a bigger reduction in taxes.
Incorporated business tax reduction
For incorporated businesses (C-corporations), the most direct impact of the tax reform is a lowering of corporate taxes.
“Tax rates for C-corporations will be changed to a flat rate of 21 percent, compared to the current progressive tax system that has a maximum rate of 35 percent," says Michael Chen, CPA, CEO and founder of Henry.tax. (The new tax rates are explored in a December 2017 post on the Journal of Accountancy.)
—Michael Chen, CPA, CEO and founder, Henry.tax
Carisa Miklusak, CEO of the recruiting and job placement company tilr, is already seeing a positive response to the new tax reduction.
“The tax 'savings' can be used for reinvestment back into the business or passed onto employees in the form of a percentage raise," she says. “The latter practice has become popular at the beginning of this year with many companies, including my own. We're sharing savings in the form of a blanket percentage raise. We feel that this recognition is likely to drive employee engagement, resulting in revenue that far outweighs the investment."
Reid Carr, president and CEO at the marketing company, Red Door Interactive, echoes a similar tactic.
“Our company should get a benefit of a lower overall tax rate, which should increase our profitability," he explains. "That means because we have an incentive plan for our employees based on profitability, they might see a bit more income from that program on a semi-annual basis."
Pass-through business entity tax deduction
Unlike corporations taxed as separate entities, sole proprietorships, partnerships, S-corporations and LLCs are "pass-through" businesses taxed through business owners' taxes. Many such pass-through businesses can now receive a 20-percent tax deduction, as indicated in Sec. 199A of the Tax Reform Act.
"If you aren't in the personal service business and have employees, you may be eligible for a deduction up to 20 percent of the taxable income from that business," says Chen. "For businesses that qualify for the 20 percent deduction, owners of the businesses will see significant tax savings at the personal level."
There are income limits. You must make less than $315,000 per year as a couple filing jointly or $157,500 in individual income.
Jason Labrum, founder and president of Labrum Wealth Management, offers an example of how this might work with the tax reform.
“A business owner who makes $200,000 per year will be able to deduct 20 percent, or $40,000, which would lower his or her taxable income to $160,000," he says. “If you assume a net effective tax rate of 20 percent, the $40,000 deduction would equal $8,000 in tax savings."
Major Changes in Equipment Depreciation
Under the old tax law, many major equipment purchases were required to be depreciated over a number of years. That meant that business owners could only write off a small portion of the expense each year for tax purposes.
“With the tax reform, immediate write-offs of 100 percent of business equipment purchases are allowed. This makes the depreciation process unnecessary," says Alexander Joyce, president and CEO of ReJoyce Financial, a wealth management firm.
According to Joyce, the provision located in section 179(b)(1) of the Tax Reform Act, allows for immediately expensing up to $1 million in equipment expenditures. Joyce feels that this could spur more investment in businesses.
“The eligible expenditures now include certain payments on rental-related property, such as roofs and heating and ventilation systems," he says. “With this in mind, businesses that purchase significant assets in a year—especially for rental units—could benefit significantly."
Reduction or Elimination of Certain Expense Write-Offs
Some expenses that you could write off prior, such as interest expense, state and local taxes and meals/entertainment expenses, have been be reduced or eliminated.
"The interest expense deduction is now limited to 30 percent of net income, although this doesn't apply to small businesses with receipts less than $25 million," says Chen. "Additionally, entertainment expenses are no longer deductible, and Net Operating Losses (NOL) are now limited to 80 percent of each year's taxable income. The latter deduction can no longer be carried back prior years."
Given the elimination of some tax benefits, it's possible that business owners could see mixed results from the tax reform, believes Chen.
"We expect the elimination of expenses will have some impact to smaller businesses. Such companies will change behavior to adapt to those rules," says Chen. "For example, if taking a client to a basketball game is less tax efficient, a great meal at a great venue may be substituted."
If you have questions about how the tax reform legislation is going to affect your business specifically, you might want to consult with a tax professional or financial planner. A financial expert can help you maximize the benefits of the new legislation while reducing its drawbacks.
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