How the Tax Reform Will Affect Small Business Owners
In this post, we’ll explain how the tax reform will affect business owners like you, so that you can be prepared moving forward.
Changes That Affect Small Businesses
Most of these changes affect all businesses, not just small companies. All changes take effect during the 2018 tax year, unless otherwise noted.
- Corporate tax rate: The new, single corporate tax rate is 21 percent, replacing the previous top tax rate of 35 percent. Going forward, the corporate Alternative Minimum Tax is eliminated. Ultimately, this change was made so that the U.S. will attract large corporations, contributing to economic growth.
- Pass-through income: This is a change that will affect many business owners; around 95 percent of U.S. businesses are considered pass-through companies. Going forward, pass-through businesses won’t directly pay taxes. Instead, they’ll pass their net earnings (and thus their tax obligations) through to their owners, who pay taxes on the earnings at the owner’s personal tax rate. Under the new tax law, these earnings will receive a 20 percent deduction.For example, on pass-through earnings of $100,000, only $80,000 will be taxed. The deduction phases out as earnings exceed $157,500 (single filers) for certain service industries, including financial, legal and health services. The deduction is capped at one-half of wage income, or one-quarter of wage income plus 2.5 percent of qualifying property.
- Expensing: Short-lived capital investments can be immediately expensed rather than depreciated. This provision is good for five years, and then phases out over the five subsequent years by 20 percentage points each year. The Section 179 deduction on equipment spending is capped at $1M, twice the previous cap, and begins phasing out above $2.5M instead of $2M.
- Interest deduction: Formerly uncapped, the interest deduction will now be limited to 30 percent of earnings before interest, taxes, depreciation and amortization. After four years, the cap will become 30 percent of earnings before interest and taxes.
- Cash accounting: If you own a small business, this is another change that will particularly affect your operations. Now, businesses can choose cash accounting if their three-year average annual gross receipts do not exceed $25M. Previously, the cap was $5M.
- Net operating losses: Going forward, carryback losses are eliminated. Carryforwards are capped at 90 percent of taxable income until 2022, when the cap drops to 80 percent. It is also important to note that net operating losses can be carried back two years, which could give businesses the opportunity to receive a refund on taxes that they’ve already paid.
- Favored industries: Lobbyists could secure special tax breaks for the following industries:
- Citrus growers: Can deduct replanting costs of weather-damaged citrus plants.
- Film/TV producers: Extension through 2022 of provision allowing full expensing of investments in first year.
- Beer/wine producers: Two-year reduction of excise taxes on domestically-produced beer on the first 6 million barrels. Excise tax cut on all wines (domestic, imported or sparkling).
The bulk of the benefits from the new tax law go to large corporations and wealthy individuals. Small businesses and middle-income taxpayers will usually see some tax relief, though the amount is highly dependent on your circumstances, such as your number of dependents, your state and local taxes, and your source of income. The self-employed and pass-through entities will qualify for a new deduction equal to their adjusted gross income. Wage workers do not receive this benefit.
These business tax changes are permanent, although personal tax changes will have to be either renewed or made permanent to avoid their phase out in 2025. That’s good for business, because it creates certainty regarding tax rates. For individuals, tax rates might go up beginning in 2025 unless Congress takes action, which is by no means guaranteed.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.