How These 4 Changes to Tax Law Will Affect American Business Owners

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  • The Tax Cuts and Jobs Act of December 2017 has brought about the largest reduction in the corporate tax rate in American history.
  • Business owners who make their income on pass-through entities can now claim 20% of it as tax-free. There are many other large tax breaks available for different business entities. 
  • However, previous tax breaks, like those for entertainment expenses, business meals, cycle-to-work schemes, and business relocation, have been scrapped or reduced.

There’s been a lot a buzz in the financial community about the Tax Cuts and Jobs Act since it was first announced in December 2017, and that isn’t dying down. The Act is the most comprehensive change of tax law in 30 years; the last time the law changed so dramatically was the Tax Reform Act of 1986.

As more of the act’s wide-ranging reforms become common knowledge, there are many reasons business owners should be excited. One thing is certain: The Tax Cuts and Jobs Act promises the majority of business owners a smaller tax bill than they’ve had in previous years. Corporate tax has been lowered from 35% to 21% — making it the largest reduction in the corporate tax rate in American history.

However, although the majority of business owners will benefit, some small business owners will be left out in the cold. Many businesses which provide professional services, such as accountancy firms and consultancies, are excluded from the legislation’s more generous tax deductions, because they neither hire a lot of staff nor generate a lot of profit. Read on to find out how changes to the tax code may affect your business, for better or worse.

How These 4 Changes to Tax Law Will Affect American Business Owners

Corporate Tax Rate Lowered by 14%

The biggest impact the Tax Cuts and Jobs Act will have on small business owners is the change in corporate tax. Previously, a business could pay up to 35% of their net income in corporate tax, but not anymore. Now, the Corporate Tax Rate is capped at 21% of net income for all corporations.

Previously, all C corporations would belong to one of four tax brackets, and pay 15%, 25%, 34%, or 35% corporate tax. So, will the new legislation mean that some businesses will have to pay more? Theoretically, yes. However, the only businesses eligible for the 15% corporate tax bracket were those making less than $50,000 per year — and most businesses that small don’t classify themselves as corporations. Thanks to these changes in corporate tax law, the vast majority of corporations will now pay less tax than they have at any point in the previous 30 years.

Tax Deductions for Pass-Through Entities

Most small businesses are not C corporations; they are instead classified as pass-through entities. A pass-through business is one where income is taxed according to the tax rate applicable to the business owner as an individual, rather than that applicable to the business. Pass-through entities include S corporations, partnerships, and sole proprietorships. Currently, 50% of the private sector’s workforce is employed by a pass-through business.

Thanks to the Tax Cuts and Jobs Act, pass-through entities will pay a much higher rate of tax than C corporations: the top individual tax rate is as high as 37% of net income. However, there are some savings to be made — but none as generous as those awarded to C corporations.

People who earn their income through, and are taxed on, the profits of pass-through entities are now eligible to deduct 20% of their business income as tax-free. This deduction will remain in effect until Jan 1, 2026. This sounds good, but it isn’t all good news; not every pass-through business owner is eligible. Business owners are only eligible for deductions depending on the following:

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  • A household income of less than $315,000, if you are married
  • A household income of less than $157,500, if you are single
  • If you and your spouse have a combined household income of between $315,000 and $415,000, you will be able to claim some portion of the 20% deduction.
  • If you are single and your income does not surpass $207,500, you should be able to claim some of the 20% deduction.

However, once you reach the upper income limits, you will be ineligible to claim a deduction if your pass-through business is classified as a service business. If your business depends on the professional reputation of your employees, be they accountants, doctors, karate teachers, or lawyers, you won’t be eligible for further deductions once you’ve reached the income limit.

If your business is not a service business, there is a silver lining. Once you reach the upper income limit, you are still able to claim a deduction. However, the amount of that deduction depends on two calculations. First, work out the total value of 20% of your business’s income. Then, make these calculations:

  • 50% of the owner’s share in the wages paid to W-2 employees
  • 25% of the owner’s share in the wages paid to W-2 employees and 2.5% of the price, at the time of purchase, of any property/machinery acquired for your business

Whichever of those results is lower is the total amount of deduction available for your business, once you’ve reached the upper income limit.

That may seem complicated, but there’s more. There are gray areas surrounding what distinguishes a service business from a non-service business. For example, if you are a business which has a roster of mechanics, but you also provide parts for cars, your service/non-service business is currently in a legal gray area when it comes to tax law. Many tax professionals are waiting for the IRS to clarify how they define service and non-service businesses, which should happen before the tax year ends in April 2019. If you have questions about business deductions or other tax-related issues, Solvable can help.

Elimination of Certain Tax Deductions

Unfortunately, it seems like many of the fruitier tax deductions previously available have been scrapped. Here are some of the deductions that are no longer applicable to businesses:

  • Entertainment expenses
  • 50% of the value of business meals
  • Transportation costs paid to employees for commuting
  • Cycle-to-work schemes
  • Expenses associated with business relocation
  • Awards for employees

Although these are small things compared to a grand tax reform, they still have the potential to leave small business owners without expected tax deductions.

Asset Depreciation

Before the Tax Cuts and Jobs Act, businesses could claim only 50% of any eligible asset, like a business property, as tax deductible in the year of its purchase. The entire amount would eventually be tax-free, but not before incremental tax breaks each year. Under the new code, from 2023 on, all assets purchased by a business will be 100% tax deductible in the year they’re bought.

As you have read, the Tax Cuts and Jobs Act has its advantages and disadvantages, depending on the type of business. If you are a business owner struggling with tax debt or tax law, we at Solvable are on hand to help you find the right tax debt relief so your business can flourish, no matter how the tax law changes.

 

Annie Beverly
Author:
Annie Beverly

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