With the tax law changes that were implemented last December, many are still trying to figure out what it ultimately means for everyone, including the government’s budget deficit. While the debate rages on about the ultimate effect of this tax bill, the best answer is that we won’t really know the full effects for several years, both positive and negative. There is, however, some certainty as it relates to small business owners.
It is fairly clear that small business owners benefit the most from this recent tax legislation. However, with the complexity of the new law and some possible unintended consequences, it’s necessary for small business owners to make sure their team of advisors understand how it affects their specific situation, and develop a plan around it. Here are several key changes that business owners should be aware of moving forward.
New Corporate Tax Rate
The new corporate tax rate is lower, now at 21 percent for 2018. Many other tax law changes are set to expire in 2025, but this one stays on the books. This new corporate tax rate is also what is known as a ‘flat tax,’ meaning it will be the same for all C corporations. In the past, the rates were tiered, at 15%, 25%, 34% and 35%. Most businesses did not fall into the 15% bracket, so almost all will enjoy a lower bracket moving forward.
Just Passing Through
What about pass-through entities like S Corporations, sole proprietorships and partnerships whose profits ‘pass-through’ to the business owners directly and they paid ordinary income on their returns? The change here is that if you are a business owner, you may be able to deduct up to 20 percent of this qualified business income. That’s the good news. The bad news is that you can only claim it if you meet some qualifications such as how much income you make (less than $315,000 and you might be able to take the full deduction) and the type of business you own. This is where it gets in the weeds a bit, but suffice it to say, if you own a non-service business you might be able to take more of a deduction than a service business. This is where your tax consultant will help you navigate these murky waters.
Bye Bye Corporate AMT
Corporate AMT was similar to the individual AMT, an additional way to calculate taxes to ensure businesses paid a minimum amount. Getting rid of this AMT for corporations translates into discarding some of the tax liabilities that companies used to factor into the AMT calculation.
It’s Hard To Say Goodbye
Put another way, taking some business deductions as you had in the past will be more difficult moving forward. Starting in 2018, deductions that many small business owners have come to count on will be harder to take or gone completely.
Entertainment expenses used to be 50 percent deductible, but no more. There are some caveats, such as food and expenses tied to educational events, but giving a pair of concert tickets to a client is no longer deductible.
Business interest had generally been deductible, such as interest on loans, but now businesses can only write off interest expense that is equal to 30 percent of its adjustable taxable income. As is the case with this tax bill, there are many caveats and complications to this rule, but suffice it to say that if you had financed your business through debt, that may not be an appealing option anymore.
The main takeaway is that many of these new tax law changes could stand to benefit business owners, but it will take some careful thought and communication between you and your team of advisors to fully understand them, develop a strategy around them that is customized to your business and then invest the time to implement them.