How Does the New Tax Law Affect Businesses?
Last week I wrote about what individual taxpayers can expect in 2018 under the new 2017 Tax Cuts and Jobs Act Law. Now, let’s take a look at the business side of things. The purpose of this blog is to highlight things that taxpayers understand, not what they expect their accountants and financial professionals to know. In other words, we won’t get “into the weeds.”
For more details, this article “What Tax Reform Means for Small Businesses & Pass-Through Entities” by Forbes writer Kelly Phillips Erb covers a lot of ground. I will bullet the major points to highlight areas that you may want to spend more time understanding in light of your business situation. The new laws are still being interpreted and we can expect more clarification from the IRS in the coming months.
Different Business Entities, Briefly Defined
- C Corporations are entities that are taxed on its own profits, and shareholders are then taxed on profits distributed as dividends (hence the term “double taxation”). Most large corporations, banks and insurance companies are C Corps, although small companies can also be C Corps.
- Pass-Through entities can be sole proprietorships, partnerships, Limited Liability Companies (LLC), Professional or Service Corporations, and S Corporations. These are all entities where the net profits/losses of the business are “passed-through” to the shareholder, partner, proprietor’s individual tax returns (hence the term).
- C Corps benefit by the reduction of the current corporate tax rate range of 15% to 39% to a flat rate of 21%. The ceiling for cash accounting has also been increased from $5 million to $25 million of annual gross receipts.
- Pass-through entities will have a new 20% deduction on “qualified business income (QBI),” subject to certain limitations. This deduction is taken against TAXABLE INCOME (page 2 of the tax return) and does not reduce Adjusted Gross Income. Also, entities designated as a “specified service trade or business” are subject to exclusions from the deduction for single taxpayers with taxable income over $157,500 and joint filers over $315,000.
- Pass-through entities designated as a “specified service trade or business” include businesses performing services in the fields of health, law, consulting, athletics, financial services, brokerage services, or basically “any trade or business where the service is based on the reputation or skill of one or more of its employees or owners.” Engineering and architecture services are excluded from this designation.
- Qualified Business Income is defined as net income from your business excluding amounts paid by an S Corp that is considered reasonable compensation, or any guaranteed payments to partners (LLC). This is the calculation on which you will determine how much of the 20% deduction you will be able to claim.
- The deduction is limited in two ways:
- The deduction is the LESSER of 20% of qualified business income, OR the sum of 50% of total W-2 wages paid by the business plus 2.5% of the unadjusted basis, immediately after acquisition, of all “qualified property.”
- If the QBI is below $157,500 for individuals and $315,000 joint filers, the 50% of W-2 wages calculation does not apply, so the deduction would simply be 20% of the QBI. The deduction is completely phased out for business owners with TAXABLE income above $415,000 if married, $207,500 if single. As a side note, real estate investors may also benefit from this deduction.
- Qualified Business Property is considered any property used in the production of QBI, that has not fully depreciated before the close of the tax year.
All business owners will want to pay attention to other areas addressed in the new law. These are subject to maximum limits, linked to amount of income from the business activity, and actual usage of vehicles:
- Increase of the Section 179 depreciation deduction which allows a business to expense up to $1 million of the cost of qualified business property, with a phase out threshold of $2.5 million, versus the current $500,000 with a phase out threshold of $2 million.
- Bonus depreciation is a deduction that allows businesses to “front-end” the deduction for depreciation of business assets. It has increased from 50% to 100% under the new law and will gradually phase out after five years. The deduction has also expanded to include “used” property.
- Luxury cars annual depreciation increases the first-year deduction from $3,160 to $10,000 before considering the bonus depreciation.
The Time to Plan is Now
Now is the time to talk with your accountant to plan your 2018 activities to take advantage of any benefits you may qualify for under the new law. Planning is the key to understanding the impact of the 2017 Tax Cuts and Jobs Act on you and your business.
Wood Smith Advisors, a woman-owned Registered Investment Advisor (RIA), is a fee-only fiduciary financial services firm that partners with its clients to simplify their financial lives. We focus on women, entrepreneurs and individuals with complex financial situations, providing objective and competent advice, education and services to help them develop and build their businesses and reach their financial goals. We can be reached by clicking here.
"Finance Made Simple" blog posts are intended for educational purposes and not for specific advice. Each person’s situation is different. Consult your financial advisor for advice relating to topics discussed.