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It’s time to decode the tax code. The Tax Cuts and Jobs Act (TCJA) was signed into law on December 22nd, 2017, touching virtually every corner of the tax code—and affecting virtually every type of business entity. Because of all the tiny details that exist in the tax solar system we call home, it’s no surprise that you may feel perplexed by the implications this new GOP tax bill will have on you and your small business.
This article will touch on some of the top ways the bill will impact each type of business entity, including what to keep tabs on as it continues to be interpreted by the pros.
How the tax bill will affect both C corps and pass-throughs
First, let’s go over how the bill impacts both C corporations and pass-through entities, since that’s where the majority of changes will take place. Here are a couple of the most prominent changes most small businesses will be able to take advantage of.
Expands bonus depreciation and Section 179
The TCJA nearly doubles the deductible amount under Section 179 from $510,000 to $1 million. This means a business can fully deduct the cost of eligible property as an expense in the year it is purchased, rather than depreciating it over a number of years.
Eligible property includes things like
- And other equipment you use to run your business.
The tax bill also raises the phaseout threshold to $2.5 million. This means that for every dollar a business spends on eligible property (that’s over $2.5 million), the limit on deductions under 179 goes down by a dollar.
Similarly, bonus depreciation (aka “full expensing”) will be expanded under the TCJA. In years past, bonus depreciation was, as the name implies, a bonus deduction that equals usually 50 percent of the cost of eligible new property. Now, the expansion of bonus depreciation under the TCJA allows for 100 percent of eligible new and used property to be deducted in the year it is purchased and put into service.
In other words, you can’t stockpile a bunch of laptops for your future expansion plans just because Best Buy is running a special. The property must be put to use the year you buy it. Expanded bonus depreciation will be available for five years and will then be phased out over the next five years.
Interest deduction limitations
For small businesses that borrow substantial sums for one reason or another, like restaurants or tech startups, the deductibility of the interest paid on that debt will have some limitations.
For companies that have sales of more than $25 million, the amount of deductible interest will be capped at 30 percent of earnings before interest, taxes, depreciation, and amortization (EBITDA) for four years. The limitation is 30 percent of EBIT after that. Any disallowed interest can be carried forward to future tax years to be deducted.
There are certain types of businesses that are exempt from this change, most notably those in commercial real estate.
How the tax bill will affect pass-through entities
Now, let’s cover pass-throughs. The vast majority of small businesses are pass-through entities, so the changes here will be wide-reaching.
Just a reminder, pass-throughs include S corporations, limited liability companies, partnerships of all kinds (i.e., general, limited, limited liability partnerships), and sole proprietorships. The profits or losses from these businesses “pass” or “flow-through” to their owners for tax purposes. Chances are, your business takes one of these forms.
20 percent deduction of qualified business income
The main impact on pass-through entities will be the 20 percent deduction of what’s being called “qualified business income” (QBI) under Section 199A. This is a new wrinkle in the tax code and EVERYONE is talking about it.
In general, it works like this: Section 199A says owners of pass-through entities will be able to take a 20 percent deduction on their QBI. For example, if you have $100,000 in QBI from an LLC, you will have a $20,000 deduction right off the top.
So, what is QBI, exactly?
It is the ordinary income (minus ordinary expenses) earned from a pass-through business that excludes any wages or guaranteed payments earned from said business. In other words, if $25,000 of your $100,000 were paid in wages, your QBI would be $75,000, and the deduction would only be $15,000.
Generally speaking, the idea behind the deduction is that it will encourage people to start their own businesses and allow them to keep more of what they earn. In spirit, it seems like a good idea, but lots of people are worried that it will invite some questionable tactics to game the system in order to take the deduction.
Case in point, there are lots of exceptions and limitations to this deduction. For example, taxpayers who are high-earners in “specified service businesses” (e.g., law and accounting firm partners) will be phased out of the deduction once they earn more than $157,500 (for single filers) or $315,000 (for joint filers). Single filers lose the deduction entirely once they earn $207,500 and joint filers are out of luck when they hit $415,000.
Funny thing about this exclusion, however. QBI from services performed by architects and engineers are exempt from these limitations. In other words, they’re an exception to the exception. The thinking here is, architects and engineers are pretty important to building stuff, so these types of services should be eligible for the 20 percent deduction.
And that’s just one example. If your business is a pass-through entity and you want to know if you’ll qualify for the 20 percent deduction, talk to your CPA stat. It’s one very important but very complex area of the TCJA.
How the tax bill will affect C corporations
Look, we understand that most small businesses probably aren’t organized as C corporations, but we’d be remiss if we didn’t explain some of the big changes that will affect them.
The biggest impact for C corps is the new 21 percent tax rate.
This is down from the 35 percent maximum rate and the cut is permanent. That means C corps will pay less taxes on their income—up to 14 percentage points less—and it will not go up in the future unless Congress passes a law. Many provisions in the TCJA are temporary (more on that in a bit), but one big permanent change is to the corporate tax rate.
Repeal of AMT
Another big change for C corps is the elimination of the alternative minimum tax (AMT).
The corporate AMT was designed to ensure that businesses pay a minimum amount of taxes, despite the myriad deductions, credits, and loopholes in the tax code. Over the years, the AMT became unwieldy and subject to a lot of manipulation, so the drumbeat to repeal it became louder and it’s finally been scrapped. Although most small businesses aren’t subject to the AMT, it’s a significant enough change to warrant a mention.
Next, we have everyone’s favorite topic—accounting.
There are two main methods of accounting: the cash method and the accrual method. In general, the cash method allows businesses to recognize revenue when cash is received. Under accrual accounting, revenue is recognized when it is earned. How and when revenue is “earned” is complex and not always straightforward, so the cash method is far simpler to use and widely preferred by small businesses.
Under the TCJA, C corps that pass the gross receipts test—not more than $25 million in sales for the past three tax years—will be able to use the cash method of accounting. This $25 million threshold is up from the current ceiling of $5 million. The cash method is also now available to businesses that keep inventory, and as a result, have had to use the accrual method. The same $25 million gross receipts will apply here.
Bring cash back onshore
Finally, if your business has income from overseas that it wants to bring back to the U.S., the TCJA will no longer tax it at 35 percent. Instead, you can bring it home for a one-time hit at a 15.5 percent rate on liquid assets (like cash), and an eight percent tax on illiquid assets (like art or other assets that are hard to sell quickly for cash).
Whew! The good news is that you’ve made it to the end of this post. Thanks for hanging with us until the bitter end. But this is just the tip of the tax iceberg. That’s why it’s best to take this tax bill stuff in small bites so you get a better understanding of how it impacts you, and of course, so you don’t choke on all the dense information coming your way.
This article contains general information but is not intended to be construed as tax advice. Each business and situation is different, so please consult with a tax professional to help you make the right choices for your company.