It’s no secret that operating a small business is hard work. You devote tons of time and energy to making smart decisions, driving profits, and doing your best to keep your taxes low.
Now that tax season is just around the corner you’re probably wondering (or outright worrying!) about how the recent Tax Cuts and Jobs Act, which took effect in 2018, will affect your tax picture this year and beyond.
If you’ve been dreading tax time because of this uncertainty, it’s time to breathe a sigh of relief: most of the changes associated with the recent tax reform will actually benefit you this tax season—and it’s good to be informed of the not-so-great changes as well so you can plan wisely for the future.
Corporate tax reform in the United States was long overdue. For too many years, corporations in the United States faced a much higher corporate income tax rate than did companies based in most overseas economies. As a result, increasing numbers of U.S. companies chose to expand more overseas rather than in the United States and to be headquartered outside the United States, which wasn’t good for the long-term health of the U.S. economy and labor market. When Congress passed the Tax Cuts and Jobs Act in late 2017, it was the most significant tax reform passage since the Tax Reform Act of 1986.
Keep reading to learn the facts about how the 2017 tax reform bill will affect you and your small business this year.
Expect a reduction in your individual income tax rates
Following the 2017 tax reform bill, the corporate income tax rate was lowered from 35 to 21 percent, a 40 percent reduction. The Tax Cuts and Jobs Act also reduced individual income tax rates by several percentage points inside most tax brackets. This comes as great news for most small business owners in the U.S who operate their businesses as pass-through entities (including sole proprietorships, LLCs, partnerships, and S-corps).
If you’re a pass-through entity, you can take a 20 percent reduction
When Congress was reworking the tax code, it recognized that many small businesses operating as pass-through entities would be subjected to higher federal income tax rates compared with the new 21 percent corporate income tax rate.
To account for this, Congress provided a 20 percent deduction for pass-through entities. Here’s an example: assume that your sole proprietorship netted you $60,000 in 2018 as a single taxpayer. That would push you into the 22 percent federal income tax bracket. But, because the pass-through deduction allows you to deduct 20 percent of that $60,000 of income (or $12,000), you would only owe federal income tax on the remaining $48,000. This major change has encouraged small business owners to feel optimistic about being able to grow their businesses.
But keep in mind that this deduction gets phased out for service business owners (such as lawyers, doctors, real estate agents, consultants, etc.) at single taxpayer incomes above $157,500 (up to $207,500) and for married couples filing jointly with incomes more than $315,000 (up to $415,000). This deduction may be limited for other types of businesses above these income thresholds, so be sure to consult with your tax advisor if you have questions.
Now you can enjoy better equipment expensing rules
The so-called Section 179 rules have historically permitted small businesses to be able to immediately deduct the cost of equipment, subject to annual limits, they purchase for use and place into service in their business. But the 2017 tax bill expanded these rules. Now, more businesses can immediately deduct up to $1 million in such equipment expense annually (up to the limit of their annual business income).
Further, this deduction can also now be used for purchases on used equipment. These provisions, which don’t apply to real estate businesses, remain in effect through 2022 and then gradually phase out until 2027 when the prior depreciation schedules are supposed to kick back in.
The maximum depreciation deduction for automobiles has been increased
The 2017 tax bill included a major increase in the maximum amount of auto depreciation that can be claimed. Under this reform, the annual amounts of auto depreciation have more than tripled.
Effective with the tax year 2018, here are the maximum amounts that can be claimed:
Year 1: $10,000 up from the prior limit of $3,160
Year 2: $16,000 up from the prior limit of $5,100
Year 3: $9,600 up from the prior limit of $3,050
Year 4 and beyond: $5,760 up from the prior limit of $1,875, until costs are fully recovered.
After 2018, these annual limits will increase with inflation for cars placed into service.
Your interest deductions have been capped
Starting in 2018, companies with annual gross receipts of at least $25 million on average over the prior three years are limited in their deduction of interest from business debt.
Net interest costs are capped at 30 percent of the business’s earnings before interest, taxes, depreciation, and amortization (EBITDA). Farmers and most real estate companies are exempt from this. Then, effective in 2022, this provision becomes more restrictive and would thus affect even more businesses. At that point, the 30 percent limit will apply to earnings before interest and taxes.
You will lose some of your meal and entertainment reductions
The tax reform bill of 2017 eliminated the entertainment expense deduction for businesses. Under previous tax law, you were allowed to deduct 50 percent of those expenses (for example, when a business entertained customers and even employees at restaurants, sporting events, and fitness clubs).
There are exceptions under the new rules: For example, on-site cafeterias at a company’s offices and meals provided to employees as well as business meals associated with travel are 50 percent deductible. Meals provided to prospective customers as part of a seminar presentation are still fully deductible. And as long as they are inclusive of everyone, holiday parties and company picnics are also fully deductible.
The health insurance mandate has been eliminated
After the Affordable Care Act (a.k.a. Obamacare) was passed by Congress in 2010, some Republicans in Congress vowed to repeal it. Following Republican Donald Trump’s election in 2016, it seemed that the pieces were in place for Obamacare’s successful repeal. But, when the late Arizona Senator John McCain gave the repeal measure his infamous thumbs-down vote, Republicans fell one vote short in the Senate.
So, the 2017 tax bill included a little-known or -discussed measure that eliminated Obamacare’s mandate effective in 2019. This mandate required people to have or buy health insurance coverage, and if they didn’t, they’d face a tax penalty. So, the penalty tax also disappears in 2019.
Under the new tax reform, net operating losses (NOLs) can no longer be carried back for two years. However, NOLs may now be carried forward indefinitely until they are used up. The carry-forward limit was previously 20 years. NOLs are limited each year to 80 percent of taxable income.
Now that you know about the most significant provisions that will affect your small business this year, you can approach tax season with confidence. And best of all, you can make informed decisions as you continue to grow and shape your small business into the vibrant enterprise you have always envisioned.