What Small Business Owners Need to Know About the New Tax Bill
You are probably wondering how the new tax bill will impact you. Especially if you are a small business owner or freelancer. Well, as usual, Shoeboxed has your back when it comes to taxes. So sit back and relax while we explain what’s changed.
A new tax bill was signed on Dec 22, 2017, and brings with it changes that will have a big impact on U.S. businesses. There’s been a lot of talk about business restructuring since the bill was announced (accountants are overwhelmed), and frankly, it’s all gotten a bit confusing.
In this post, we will explain in plain English about the biggest changes to the tax code, and what you should consider doing to maximize your future deductions.
What has changed
Quite a lot has changed with this new tax bill, but we’ll start with what seems likely to impact most small businesses. The 20 percent deduction for pass-through businesses.
There is now a 20% deduction for pass-through business income
- 20 percent of pass-through qualified business income will be deductible.
- The deduction is set to expire after 2025.
- Single filers who earn more than $157,500 or joint filers over $315,000 annually aren’t eligible for the full 20 percent deduction but instead will use a calculation to determine their deduction.
- Certain service industries aren’t eligible for the deduction.
What’s a pass-through business? It’s a business that does not pay corporate income tax and instead is taxed under the owner’s individual income tax. This includes sole proprietorships, partnerships and S corporations.
About 95% of businesses in the U.S. are pass-through, according to the Brookings Institute.
So, how does the deduction work? If you are below the income cap, $157,500 for single filers and $315,00 for joint, it’s pretty simple. You will only be taxed on 80 percent of your business income.
For example, if your pass-through business income is $100,000, you can deduct 20 percent. So your deduction is $20,000, and you are taxed on $80,000 of your business income.
Pretty simple right? Well if you are below the income cap, it is. Earn more than $157,000 per year? Things get a little more complicated.
There’s a bit more calculation involved to determine your deduction if you are above the income cap. The deductible percentage would be set at the higher of 50 percent of total wages paid or 25 percent of wages plus 2.5 percent of the cost of tangible depreciable property.
The tax bill also places limits on “specified service businesses.” If you are in a specified service industry, and your taxable income exceeds $207,500 for single or $415,000 for joint filers, you aren’t eligible for a deduction at all.
What do they mean by “specified service businesses?” Basically, any business where the main product is a service. This includes businesses like doctor’s offices, law firms and investment managers.
Note that engineers and architects are specifically excluded from this category.
As the bill is written, the pass-through deduction will expire after 2025. But it can be extended through legislative action.
So, what if you aren’t a part of the pass-through business category? Well, things have changed for you too.
The corporate tax rate is now 21%
This is a big change. The new bill reduces the corporate rate to 14%, down from 35%. This is the lowest corporate rate since 1939, and unlike the pass-through deduction, it has no set expiration date.
There’s not a lot of complicated calculation involved with this part of the bill. But, some business owners are going to want to determine if they would benefit from restructuring. Either from a pass-through business to a C corporation or vice versa.
A restructure could well be worth it for some businesses. Especially If you are a high earner in a specified service industry.
Calculating your potential tax burden using historical or expected numbers can give you a better idea of how to maximize your savings. Will converting to a C corporation and using the lowered corporate rate save money? Or will the new deduction make it even more beneficial to be classified as a pass-through business?
Keep in mind that restructuring comes with legal fees, so factor in that cost before committing to changing.
You will want to get a tax professional to review everything, especially with further changes in how deductions work.
There’s been a lot of talk about itemized deductions being eliminated, but that didn’t end up happening. A few have been removed from personal tax filings, and many business expenses still remain deductible. We’ll focus on a few notable changes for businesses.
Employee meals are now 50% deductible
Businesses can no longer deduct the full cost of food and meals provided for employees on company premises or at the convenience of the employer.
This partial cut goes all the way after 2025, when, according to the bill, employee meals won’t be deductible at all.
Business entertainment expenses are no longer deductible
The bill removes the previous 50 percent deduction of business entertainment expenses. This means that costs associated with entertainment, amusement or recreation are no longer deductible. This includes dues for club memberships.
The bottom line
There are some big changes in this bill. There’s a 20% deduction for qualified pass-through businesses and a calculated deduction for many others. A tax cut for corporations brings their rate down to 21 percent from 35. And there are changes to how businesses can deduct expenses.
Since business expenses are still largely deductible, tracking them is still a must. At Shoeboxed, we remain committed to helping your business simplify your expense tracking and providing peace of mind should an audit occur.
Do you have plans to restructure your business in light of the new tax bill? If so, please share your thoughts with us below in the comments section.