On Wednesday, 12.20.2017, Congress passed the largest tax legislation in many decades. According to small business tax expert Barbara Weltman, here are major changes related to small businesses that, unless noted, start during the calendar year 2018.
- The top tax rate on C corporations drops to a flat 21% (down from 35%).
- Owners of pass-through businesses will continue to pay tax at their individual tax rates, all of which have decreased slightly. But there will now be a 20% deduction of business income. (Note: There are numerous restrictions on this deduction that come into play when income exceeds set limits.)
- The deduction does not reduce business income or adjusted gross income. They are taken into account in figuring taxable income.
Eligibility rules for using the cash method of accounting have been expanded so that businesses with average annual gross receipts in the three prior years not exceeding $25 million (indexed for inflation after 2018) do not have to use the accrual method; they do not have to keep inventories (i.e., they can treat inventories as non-incidental materials and supplies).
Expensing and bonus depreciation
The Section 179 deduction (first-year expensing) can be claimed for eligible property up to $1 million. The phase-out of this limit begins when total annual purchases exceed $2.5 million. These dollar limits, as well as the $25,000 limit for buying a heavy SUV, will be indexed for inflation after 2018.
Bonus depreciation, which is a first-year depreciation allowance for buying business equipment and machinery, is doubled to 100% for property placed in service after September 27, 2017, but only temporarily. The dollar limits on depreciating a so-called “luxury vehicle” have been favorably changed.
Generally, a deduction for interest is limited to 30% of a corporation’s income, with unused amounts carried forward. But this restriction does not apply to small businesses (average annual gross receipts of $25 million or less).
Net operating loss
NOL carryback is eliminated, except for a carryback for certain losses incurred in the trade or business of farming. The carryforward is capped at 80% of taxable income (90% after 2022) or the carryover amount if less.
Like-kind exchanges (barter)
Tax-free treatment for exchanges is limited to exchanges of reality; it no longer applies to exchanges of tangible personal property
Travel and entertainment expenses
The deduction for an entertainment activity is repealed, although the 50% deduction for business meals remains.
The deduction for transportation fringe benefits has been eliminated, but employees can continue to exclude them from gross income if employers still offer them.
Credit for paid family leave
There is a new credit for employers that pay wages to employees on family or medical leave. This new credit only applies for 2018 and 2019.
Special tax incentives apply for investments in designated “opportunity zones.”
Technical terminations of partnerships
This rule is repealed. Termination continues to occur if no part of any business, financial operation, or venture of the partnership continues to be carried on.
Note: Each small business owner and individual taxpayers have unique financial and legal situations so it is important for you to talk directly with your financial, legal and tax advisors to determine how the Tax Cuts and Jobs Act may impact their specific, personal situation. Information shared here should not be interpreted as advice.
Here is another before-and-after look at provisions in the bill that relate to small businesses and their owners. (Source: Tax Foundation)
|Provision||Current Law||Conference Report|
|Corporate Tax Rate||Multi-bracket corporate income tax structure with a top marginal rate of 35 percent and a bubble rate of 39 percent.||Single-rate 21 percent corporate income tax.|
|Treatment of Pass-Through Income||Subject to individual income tax rates and brackets.||Adopts a 20 percent deduction for pass-through income, limited to the greater of (a) 50 percent of wage income or (b) 25 percent of wage income plus 2.5 percent of the cost of tangible depreciable property for qualifying businesses, including publicly traded partnerships but not including certain service providers. Limitations (both caps and exclusions) do not apply for those with incomes below $315,000 (joint), and phase out over a $100,000 range.|
|Capital Investment||In relevant part, allows 50 percent bonus depreciation of short-lived capital investment, such as machinery and equipment, through 2020, and offers Section 179 small business expensing with a cap of $500,000 and a phaseout beginning at $2 million.||Allows full (100 percent) expensing of short-lived capital investment, such as machinery and equipment, for five years, then phases out the provision over the subsequent five, and raises Section 179 small business expensing cap to $1 million with a phase-out starting at $2.5 million.|
|Alternative Minimum Tax||Applies a 20 percent tax rate to a more broadly defined alternative definition of income.||Corporate AMT is repealed.|
|Tax Treatment of Interest||Allows a full deduction for interest paid (with no cap).||Caps net interest deduction at 30 percent of earnings before interest, taxes, depreciation, and amortization (EBITDA) for four years, and 30 percent of earnings before interest and taxes (EBIT) thereafter.|
|Net Operating Loss (NOL) Provisions||Generally, net operating losses can be carried back two years or forward twenty years, with no limits with regard to taxable income.||Eliminates net operating loss carrybacks while providing indefinite net operating loss carryforwards, limited to 80 percent of taxable income.|
|Cash Accounting||Businesses with less than $5 million in income may elect to use the cash method of accounting.||Increases eligibility to businesses with up to $25 million in income.|
|Business Credits and Deductions||Provides a range of business credits and deductions.||Modifies, but does not eliminate, the rehabilitation credit and the orphan drug credit, while limiting the deduction for FDIC premiums. Amortizes the Research & Experimentation Credit after 2021.|
|International Income||Imposes a worldwide system of taxation.||Moves to a territorial system with anti-abuse rules and a base erosion anti-abuse tax (BEAT) at a standard rate of 5 percent of modified taxable income over an amount equal to regular tax liability for the first year, then 10 percent through 2025 and 12.5 percent thereafter, with higher rates for banks.|
|Provision||Current Law||Conference Report|
|Estate Tax||$5.6 million estate tax exemption, adjusted annually for inflation.||Doubles the estate tax exemption in 2018 (would continue to be adjusted for inflation, now C-CPI).|
|Individual Mandate Penalty||Imposes a penalty of $695 or 2.5 percent of income (with a deduction), whichever is higher, to those who forgo health insurance.||Reduces the individual mandate penalty to $0 in 2019, effectively repealing it.|
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