To gain a better understanding of the TCJA and how it will affect your business, you’ll need to understand these key highlights first.
The tax rates on regular C corporations has indeed been lowered significantly– from a rate of 35% to 21%. However, the former graduated tax rates for corporations have been replaced by a flat tax; all C corporations now have one tax rate of 21%. Also repealed: the corporate alternative minimum tax (AMT).
When it comes to owners of pass-through entities who pay tax on their share of business profits on their personal returns, things are more complicated. Owners of sole proprietorships, partnerships, limited liability companies, and S corporations pay a tax based on seven graduated tax brackets as they have always done. These brackets have been lowered to 10%, 12%, 22%, 24%, 32%, 35%, and 37% (down from 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%).
While there’s no special tax rate for income from pass-throughs, there is a new deduction that effectively lowers the tax rate, called a qualified business income deduction–roughly 20%. However, the deduction phases out, or is eliminated, once a business owner’s total taxable income exceeds the threshold amount ($157,500 for singles; $315,000 for married business owners filing jointly). Those in service-type businesses with substantial income may not be able to claim the new deduction at all.
The deduction is not an offset to business income, but is instead deducted on the owner’s personal return in the same way as standard or itemized deductions. Given that, it appears this deduction won’t reduce a self-employed owner’s net earnings for purposes of self-employment tax.
What does this all mean? You may be able to claim a new deduction if you’re profitable, but if you’re not, the treatment of business losses may limit what you can write-off. Beware of the new “excess business loss” limitation.
If you want to invest in new equipment, software and hardware, furniture, or other items for your business, you likely will be able to write-off the entire cost in the year you place them into service. The following deductions apply even if you finance the purchase in whole or in part:
There are also more generous write-offs allowed for the purchase of business vehicles and more favorable rules apply for writing off the cost of certain improvements to your facilities.
The ability to use the cash method of accounting (which is easier to track) can now be used by businesses with average annual gross receipts in the three prior years of $25 million or less, otherwise known as the “gross receipts test.” Per this test, businesses with inventory don’t have to account for them if they meet certain criteria. Instead, inventories can be treated as non-incidental materials and supplies, which are usually deductible in the year they’re sold to customers.
With some deductions ending, others have been curtailed. Businesses can no longer write-off certain employee benefits and other expenses, including:
The net operating loss deduction is now cut down to 80% of taxable income and it can no longer be carried back by most businesses. But the carryforward, which had been capped at 20 years, is now unlimited.
There’s a new credit for employers that pay employees at least 50% of their pre-leave wages while on family and medical leave (the credit amount increases as the amount of paid pre-leave wages increases). But, the credit only applies for 2018 and 2019, and only for employees earning no more than $72,000 in 2018 (it could change for 2019).
The tax credit for rehabilitating certain old businesses has been repealed. The credit for rehabbing certified historic structures remains.
Even with this brief overview, you can see that there are winners and losers. You may benefit from one change but are no longer able to take other tax breaks. It’s essential to work with your tax advisor to determine how the new law affects you and your business. Factor in these changes in business planning for 2018, including decisions about hiring and employee benefits, investments in capital assets, and more.