In the wake of U.S. tax reform enacted on December 22, 2017, many small businesses are facing an entirely new financial landscape for their 2018 tax filings.
The new law altered corporate tax rates, eliminated many popular deductions, and modified or limited numerous other tax breaks that potentially impact small businesses.
If you own, advise or invest in small businesses, hopefully you entered 2018 with a full understanding of tax reform and you’ve had conversations with a tax professional to make sure you understand what’s coming.
However, to avoid some potentially nasty surprises, here’s a quick summary of the biggest tax reform changes for small businesses and how they could end up saving money or paying the price.
Corporate Tax Rates
New U.S. tax law has reduced the income tax rate on regular corporations (also known as C corporations). It dropped from a top rate of 35% to a flat rate of 21%, and personal service corporations also get the 21% rate.
This has been a major benefit for most companies, but some small C corporations can end up paying a bit more in taxes because the law didn’t keep the 15% corporate rate on the first $50,000 of taxable income. Thus, C corporations with lower taxable income could end up paying more on their 2018 federal tax returns.
The lower tax rate for C corporations also led many small business owners to consider converting their sole proprietorships, partnerships and S corporations into a C corporation. But this was not necessarily a good strategy for many small businesses.
C corporations are taxed on their income, and their shareholders must pay tax on dividends. Since shareholders are often the small business owners themselves, that could mean “double” taxation. Fortunately, this only impacts C corporations if they pay dividends.
In addition to cutting corporate tax rates, U.S. lawmakers included some relief for individuals who own pass-through entities such as S corporations, partnerships and LLCs. In these cases, these entities pass their income to their owners for tax purposes.
As of 2018, filers can now deduct 20% of their qualifying income for tax purposes. But there are many anti-abuse rules and restrictions, most of which apply to high income earners.
Among these, there are two rules that apply to taxpayers with taxable incomes over $157,500 on an individual return or $315,000 on a joint return. First, the break phases out for people in many professional service fields. If you’re in an affected field and your taxable income exceeds $415,000 for joint returns or $207,500 for all others, you get zero deduction for that business.
There is also a W-2 wages-paid limitation for high-income earners, which applies even if a person isn’t engaged in a specified service business. This limit caps the deduction at the basic 20% or, if the deduction is lower, a figure that considers W-2 wages paid by the firm and the basis of certain assets.
Firms can now write off the entire cost of qualifying business assets purchased and put into service after Sept. 27, 2017. This lasts until 2022 but then phases out 20% for each year thereafter. The break also applies only to new and used assets with lives of 20 years or fewer.
This means now may be the time to buy qualifying new or used business assets before the tax breaks begin to phase out and decline.
Additionally, the cap on expensing business assets has increased. The maximum amount a taxpayer can expense rather than depreciating new or used assets is now $1 million. These figures will be adjusted annually for inflation, but it’s important to remember that the limitation phases out, dollar-for-dollar, once you place more than $2,500,000 of assets in service during the year.
More property is also eligible for expensing, including depreciable personal assets that are predominantly used to furnish lodging. These include beds, refrigerators, and stoves in hotels, apartments and dormitories. Also eligible are certain improvements made to commercial buildings, such as roofs, HVAC equipment, fire protection and alarms, and security systems.
Small businesses may want to make sure they capitalize on these expensing opportunities.
Vehicle Tax Breaks
For 2018 and beyond, now may be a good time to take advantage of tax breaks for purchases of passenger automobiles. Annual depreciation caps for passenger vehicles have significantly increased under new U.S. tax law. If bonus depreciation is claimed, the first-year ceiling is $18,000 for cars acquired after Sept. 27, 2017 and put into service during 2018.
The second- and third-year caps are $16,000 and $9,600. After that, the cap becomes $5,760. For vehicles purchased before Sept. 28, 2017 but put into service in 2018, the first-year cap with bonus depreciation is $16,400. If no bonus depreciation is taken, the first-year ceiling drops to $10,000.
Potential tax breaks are even larger for bigger vehicles due to bonus depreciation. If you purchase a heavy SUV for your business, you can write off up to 100% of the cost. If you buy a heavy pickup truck for business use, you can expense up to the full cost.
Meals and Entertainment
Before 2018, businesses could generally write-off half their business-related entertainment costs, but the new tax law eliminated this deduction. That means no tax breaks for taking clients and customers to sporting events, shows, golf courses, and incurring similar costs.
However, the IRS later issued guidelines money spent on taking clients or staffers out for meals would still be 50 percent deductible. Companies that haven’t already adjusted their spending on meals and entertainment should definitely do so, and they may also want to consider meals as their primary alternative to other ineligible activities.
The new U.S. tax law ended the popular write-off for 9% of income derived from domestic production activities. This affects tax years beginning after 2017, so many small businesses may be paying a bit more in taxes as a result.
Employers can no longer deduct the cost of transportation-related fringe benefits for commuting employees, such as parking and mass transit passes. This deduction was eliminated regardless of whether the employer pays the costs directly or provides reimbursement or a compensation reduction agreement.
However, employees can still use up to $260 a month in pre-tax money to cover parking, mass transit passes and vanpools. Also, employers that subsidize employees who ride bikes to work can continue to take a tax deduction for their contributions, up to $20 per month per employee. But cyclists will now be taxed on this subsidy.
Net Operating Losses
U.S. tax reform also reduced the tax deduction for net operating losses (NOLs). NOLs will only be able to offset 80% of taxable income in future years, and NOL carrybacks are generally prohibited.
Under previous tax law, NOLs could be carried back two years and carried forward 20 years. Now there are no carrybacks, but NOLs can be carried forward indefinitely.
Family Paid Leave
Companies that provide paid family or medical leave for workers are eligible for a temporary tax credit for 2018 and 2019. It’s generally equal to 12.5% of wages paid during the time of leave, but the credit is larger for employers that pay workers over half their normal wages while on leave.
However, rules and limitations apply to this tax break. For example, employers must have a written policy that gives full-time workers at least two weeks of paid family and medical leave each year. Leave time is prorated for part-time workers. The credit also does not apply to employees with total wages exceeding $72,000.
Capped Businesses Losses on Individual Returns
Under the new tax law, there are new limits on individual taxpayers who take large business losses on their returns. A couple filing a joint return is limited to $500,000 in businesses losses on their return, while a single filer can take no more than $250,000 in losses.
Trade or business losses that exceed these caps are non-deductible, but you can carry forward any excess. Also, this limitation applies after application of the current passive-activity loss rules.
An exchange of property is generally a taxable transaction, but there is a new exception when investment or business property is traded for similar property. In the case of a like-kind exchange, any gain that would be triggered by the sale of such property is deferred. Also, the new law now restricts its use to real estate, and tangible personal property such as heavy equipment is no longer eligible.
Reviewing Your Tax Liabilities and Strategies
Of course, any examination of potential tax breaks and liabilities should include a consultation with a tax professional. The new tax law is complex and involves new deductions, rules, restrictions and limitations not included here.
It’s also important to seek additional strategic advice to help you minimize any negative impact from tax reform and find the best opportunities to leverage it for your benefit.
Toward that end, it’s often beneficial to work with a consultant and expert in financial planning and analysis (FP&A) or corporate development expert. That’s where our team at SpareHire can help.
We offer access to a network of over 5,000 of the world’s top independent consultants, including top-tier strategists, financial analysts and other experts.
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