The Tax Cuts and Jobs Act (the “TCJA”) legislation was passed and signed in December 2017, and took effect January 1, 2018. Many of the changes in the TCJA are currently set to sunset in 2025. The TCJA makes sweeping impacts to tax landscape and is designed to spur economic growth, according to Matt D’Angelo, staff writer for Business News Daily.
As a small business owner, it’s important to start now to incorporate all the changes from the TCJA into your 2018 business plan, so you can plan for whatever impact TCJA may have on the way you conduct business in 2018 and the coming years. The major changes in the TCJA include reshaping the tax brackets for individuals, permanently repealing the alternative minimum tax for corporations as well as reducing the top tax rate for corporations, a 20 percent deduction on qualified business income for pass-through entities, and increasing the annual limit for the Section 179 deduction from $500,000 to $1 million. The changes set out in the TCJA are for the 2018 tax year, or the tax return that is generally filed in 2019.
The twenty percent deduction on qualified business income
One of the biggest changes for small businesses under the TCJA is the 20 percent deduction on qualified business income. Qualified business income is the ordinary income minus ordinary expenses, wages, or guaranteed payments of the pass-through entity. This deduction, applicable to pass-through entities such as sole proprietorships, partnership and S corporations, which entity types characterize most small business structures, will get a 20 percent deduction on qualified business income. The deduction is applied before the income is passed-through to the individual business owner as taxable income.
To illustrate, if you, as a small business owner, own a clothing boutique store and have annual business income of $150,000 for the 2018 tax year, the 20 percent deduction on qualified business income will reduce the taxable income to $120,000. The 20 percent deduction on qualified business income isn’t applied equally, however. Small business owners that own service-based businesses, such as owners of law firms and accounting firms, can only claim the deduction on qualified business income if their annual income is below $157,000 if single or $315,000 if married. According to Jim Blasingame, creator and host of The Small Business Advocate Radio Show, due to this inequity, small businesses will face a tax-compliance nightmare as the IRS interprets who qualifies.
New limits on the Section 179 Deduction
Another big TCJA change for small business owners is the change to the Section 179 deduction. The Section 179 deduction allows businesses to take a deduction for capital expenditure assets in the first year of the asset rather than spread the deduction out over the useful life of the asset. The annual limit for the Section 179 deduction for tax year 2017 was $500,000, raised to $1 million by the TCJA for tax year 2018. The annual Section 179 deduction limit generally applies to tangible property assets such as new and used equipment and off-the-shelf computer software, and for tax year 2018, includes property such as eligible nonresidential land and buildings. While the increase in the annual limit for the Section 179 deduction will help some small business owners take more Section 179 deduction for tax year 2018 than they were able to for tax year 2017, not all small business owners are able to purchase enough qualified assets to take advantage of the annual limit increase. It remains unclear, at this time, what impact this will have on tax relief for small business owners.
Time to consider a different type of structure?
The TCJA also reduced the tax rate for C corporations. Small business owners that are currently structured as pass-through entities may want to consider restructuring to a C corporation to take advantage of the big reduction in the top corporation tax rate from 35 percent to 21 percent. When comparing the 21 percent corporate tax rate to the individual rate, the rate most pass-through entities are taxed at, the 21 percent corporate tax rate could be tempting. It is important to remember, however, that corporations, unlike pass-through entities, are subject to double taxation. Corporations are double taxed because the income of a corporation is taxed, and then the income is taxed again when the corporation distributes its income to its shareholders and the shareholder pays tax on the shareholder’s dividends. As a small business owner you will have to evaluate your business model to see if switching from a pass-through entity structure to a C corporation structure would really be a benefit tax-wise. As stated by Nellie Akalp, CEO of CorpNet.com, “business owners should continue to think about their business structure in terms of their specific business needs and practices, as opposed to focusing solely on the changes from the Tax Cuts and Jobs Act. It’s also smart to wait for the IRS to release additional guidance on abusive situations.”
Other interesting TCJA changes
In addition to the changes – the 20 percent deduction on qualified business income and the reduction in corporate tax rate – that will make the biggest impact on the small business owner, there are some other changes to take consider in reshaping your 2018 business plan.
TCJA expanded bonus depreciation from 50 percent of the cost of eligible new property to 100 percent of the cost of eligible new and used property for the year the eligible property is purchased and put into use.
The TCJA also permanently eliminated the alternative minimum tax (“AMT”) for C corporations, getting rid of an archaic tax structure for corporations. However, the AMT remains in place for individuals.
There are many other changes that may impact small business owners, either through owning a pass-through entity or a C corporation, or just in trying to plan individually for the 2018 tax year. Be on the lookout for guidance from the IRS to help you navigate all the twists and turns of TCJA. And of course, it’s always a good idea to consult your trusted tax advisor when you have a question or need tax advice, especially with these sweeping tax changes for tax year 2018.
Small business owners need direction and goals to be successful, and creating a plan to establish a direction to help achieve goals is a great way to set up a roadmap for success for the year. As a small business owner, making and sticking to the plan can help you have your best year yet.
Author: Theresa Sonnleitner
Theresa is a tax creative writer and editor with over 200 tax-related posts. She also enjoys writing about travel, fitness, food, and lifestyle.