As we head into tax season, many small businesses are eager to see what changes the new tax law has in store for them. The law has been widely billed as business-friendly for everything from multinational corporations to sole proprietors. But it affects different types of business in different ways. Some business owners and the self-employed may wish to reconsider how they classify their business.
What can the small business owner really expect this year? Here are some of the most significant changes:
Tax cut for pass-through businesses
S corporations, LLCs, partnerships and sole proprietorships are all examples of pass-through businesses, in which the income from the business is “passed through” to the business owner's individual tax return. The net income of pass-through entities is effectively taxed at individual tax rates. The new law creates a 20% deduction on income for pass-through entities, which means many of these companies get to deduct 20% of their income, right off the top of their tax returns.
The deduction only applies to qualified business income. There are some limitations on the deduction. For example, service businesses such as law firms, doctor's offices and investment offices can only take the 20% deduction if they make less than $315,000 (for married couples).
If your business is a C corporation, those taxes have been simplified. Under old law, C corporations paid graduated federal income tax rates ranging from 15%‑35%. For tax years beginning after December 31, 2017, there’s a flat 21% corporate rate, so some lower-income business will see their rate go up. Personal service corporations previously paid a flat 35% rate, and that reduced rate also now applies to PSCs.
Changes to deductions and depreciations
Section 179 deductions: Section 179 of the Internal Revenue Code allows businesses to deduct the full purchase price of certain types of equipment and software. If you buy (or lease) a piece of qualifying equipment, you can deduct the purchase price from your gross income. That’s good enough, but the new tax law doubles the maximum allowance to $1 million from the previous limit of $500,000. The dollar-for-dollar phaseout above $2 million has been raised to $2.5 million, although the maximum allowance can’t exceed the amount of income from business activity.
Bonus depreciation: Bonus depreciation allows a business to take an immediate deduction on the purchase of eligible new business property. The new law raises the bonus depreciation deduction from 50% to a full 100% for the next five years, before gradually phasing it out over the following five years. The deduction also now includes used property that would otherwise qualify under this provision.
Some deductions, though, are moving the other way. Under the new law, most businesses cannot deduct interest expenses in excess of 30% of adjusted taxable income, starting with tax years beginning after December 31, 2017. The 50% deduction for entertainment expenses that are related to the conduct of business has been repealed. The deduction for employee transportation benefits — including mass transit passes and parking privileges — has also been repealed. The annual depreciation limits for “luxury cars” intended for business use has been raised from $3,160 to $10,000.
New tax credit for family leave
There is a new temporary tax credit for employer-paid wages disbursed for family or medical leave. The amount of the credit ranges from 12.5%-25%, depending on the amount paid. But take advantage of it while you can, because the credit disappears after 2019.
For business net operating losses that arise in future years, the maximum amount of taxable income that can be offset with deductions has been reduced for most instances from 100% to 80%. In addition, losses incurred in those years can no longer be carried back to an earlier tax year. But there is some good news for your tax planning this year: Net operating losses can now be carried forward indefinitely.
End of the AMT
Much has been made of the fact that the new law gets rid of the corporate alternative minimum tax. The AMT had made it difficult for businesses to reduce their tax bill much lower than the “alternative” rate of 21%. But the AMT only applied to businesses making more than $5 million per year, which excludes most companies that think of themselves as “small businesses.”
Things to Consider
- Overall tax rates have been simplified and cut for pass-through businesses.
- Many popular deductions have been expanded, while others were reduced or repealed.
- It may be time to reconsider how you classify your business.
Neither Transamerica nor its agents or representatives may provide tax, investment or legal advice. Anyone to whom this material is promoted, marketed, or recommended should consult with and rely on their own independent tax and legal advisors and financial professional regarding their particular situation and the concepts presented herein.