Small Business Owners: Will Your Taxes Go Up or Down?
The recent tax overhaul made significant tax rule changes, and you may be wondering whether this means your business will pay more or less under these new rules. The short answer is that it depends. Tax changes, most of which go into effect in 2018, could reduce your taxes, increase them, or have a negligible impact.
If you have a C corporation
If your business is set up as a regular corporation (C corporation), the top corporate tax rate drops from 35 percent to 21 percent starting Jan. 1, 2018. What's more, this rate is a flat tax; there is no graduated rate schedule.
If you own a pass-through entity
If your business is a sole proprietorship, partnership, limited liability company, or S corporation (a pass-through entity), business items pass through to you and are taxed on your personal tax return. Under the new law, there is no special tax rate on pass-through income. The tax brackets for individuals have been lowered, with the top one declining from 39.6 percent to 37 percent.
What's new for pass-throughs is a 20 percent deduction of "qualified business income." Essentially this works out to business profits for the year (there are a number of twists and turns in computing qualified business income so it's not exactly your profits). However, if your taxable income (not merely business income) exceeds $315,000 if you file a joint return or $157,500 if you file any other type of return, limitations come into play. This is especially true if you are in a "specified service business" (a business involved in the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services, or any business where the principal asset of the business is the reputation or skill of one or more of its owners or employees). You may get little or no deduction in this case.
There's also a change in how business losses are treated. For pass-throughs, an "excess business loss" (an amount over a dollar threshold fixed by law) can't currently be deducted. Instead, it's carried forward and essentially becomes part of the net operating loss carryforward (see below).
Some deductions have been greatly improved, while others have been curtailed or eliminated. There are more favorable rules now for writing off the cost of buying equipment, business vehicles, and certain improvements to your facilities. The changes may help to reduce your taxes.
The follow deductions have been removed:
- Business entertainment costs
- Domestic production activities deduction
- Transportation fringe benefits and moving expense reimbursements for employees
(On a personal income tax level, you can't ignore the cap on deducting state and local taxes. This means that owners who pay state taxes could see their federal tax bill rise.)
There's no federal law requiring you to pay an employee who goes on leave for family or medical reasons, but if you choose to do so, there's a new tax credit. As long as the payment is at least 50 percent of pre-leave wages, and meets several other substantial requirements, you may qualify for a tax credit for this (the amount of the credit varies with the amount of pay). But it's only for leave pay for an employee earning up to $72,000 in 2018, and the credit is set to end after 2019.
There are some key changes in accounting rules that may impact the timing of when income and deductions are taken into account. There are additional rules and exceptions, but generally, if your gross receipts in the three prior tax years do not exceed $25 million ("gross receipts test"), the business may be able to use the cash method of accounting (which is simpler than the accrual method many businesses are otherwise required to use). Also, businesses that meet the same gross receipts test do not have to account for inventories, and can instead treat items as non-incidental materials and supplies (usually deductible when items are sold to customers).
The net operating loss rules have been changed for most businesses, limiting the offset to taxable income at 80 percent (rather than the 100 percent allowed for losses arising in 2017 or earlier). What's more, there's no carryback, but now there's an unlimited carryforward instead of a 20-year period.
As you can see, the overall impact of these changes is difficult to discern. It’s important to work with a tax advisor and look at your unique business situation. Also, monitor IRS guidance on the new rules as it’s released, which can be helpful as you plan for your business.