6 ways the 2018 tax reform could impact your small business
The Tax Cuts and Jobs Act of 2017 (TCJA) — the new tax bill — is in effect and could lead to significant changes for small business owners.
While your accountant may do much of the heavy lifting, it’s important to learn about the new tax laws so you can anticipate how they could impact you or your employees. We explore some of the major changes below and point you toward resources that can help you learn more.
1. A 20 percent income tax deduction for some pass-through entities
“The biggest change is the introduction of the Section 199A qualified business income (QBI) deduction,” says Catherine Derus, owner of Brightwater Accounting. “Eligible pass-through entities (businesses taxed as sole proprietorships, partnerships, and S Corps) can deduct up to 20 percent of their QBI for income tax purposes.” As the company’s earnings get passed on to you, the business owner, the deduction could greatly decrease your tax bill.
The new deduction starts to phase out for single individuals who earn $157,500 or more and married couples filing jointly who earn at least $315,000. “Once you are over the threshold, the deduction may be limited as it takes into account wages paid by the business, qualified property, and whether you operate a specified service-based business (e.g. attorney, accountant, doctor, etc.),” says Derus.
Also, keep in mind that even if you can claim the deduction, you may still have to pay self-employment taxes on your total income from self-employment.
2. A new income tax rate for C corporations
If your small business is incorporated as a C corporation, your business’ income tax rate will now be 21 percent. Previously, the tax rate varied from 15 to 35 percent depending on the business’ taxable income for the year.
3. You can no longer deduct entertainment expenses
Previously, a business could deduct 50 percent of the expenses it paid for meals or entertainment when the activity was related to business. For example, taking a client out to a show and dinner.
“Business owners can still deduct 50 percent of meal expenses if the taxpayer (or an employee of the taxpayer) is present and the food or beverages are not considered lavish or extravagant,” says Derus. “However, the entertainment-related deduction was eliminated. “So, if you take a client to a basketball game, the food and drinks you purchase might be deductible, but the tickets are not.“
4. A tax credit for offering paid family or medical leave
If you offer employees paid family or medical leave, you may now be able to claim a tax credit for 12.5 to 25 percent of the qualifying wages you paid during up to 12 weeks of leave. The credit will only be available for a two-year period, which ends on Dec. 31, 2019.
5. Higher section 179 deduction and bonus depreciation limits
The new tax law has several changes related to deducting business expenses. Two of these are an increase to the section 179 annual limits and a temporary increase for bonus depreciation. Both allow businesses to deduct part, or all, of their qualified expenses in the current year rather than depreciating the expense over time.
For example, if you purchase a $300,000 machine that has an expected 10-year lifespan, you may be able to deduct the entire amount this year or $30,000 each year for the next ten years.
The new tax bill means you can now elect to expense up to $1 million (rather than $500,000) for qualifying purchases in the first year. The phase-out threshold also increases to $2.5 million from $2 million. This means that once your qualified expenses go above $2.5 million, each dollar you spend will decrease how much you can deduct by a dollar. If you spend $3.5 million, that could completely offset the $1 million limit and you might not be able to use the section 179 deduction. Both the $1 million and $2.5 million dollar limits will be adjusted for inflation moving forward.
There is also a temporary increase in bonus depreciation from 50 percent to 100 percent of an eligible product’s cost, although the higher limit will begin phasing out in 2023. With bonus depreciation, you may now be able to fully depreciate the cost of qualified used and new property that exceeds the section 179 limits. Or, you may be able to carry over the deduction if your business didn’t qualify for a section 179 deduction because it didn’t have a profit this year.
Additionally, there are temporary increases to the depreciation limits for new-to-you vehicles that you use for business at least 50 percent of the time.
6. Changes to fringe benefits
If you offer fringe benefits to employees, such as free snacks or reimbursement for commuting expenses, there are several changes that could impact your business.
Some of these may have a greater impact on your employees than your business, but you may want to be aware of them so you can help your employees understand what’s happened. Also, if you’re an employee of your business, these changes could affect you, too.
- You can no longer deduct expenses for transportation benefits unless the expense is required to keep your employees safe. However, you can still offer programs that allow employees to put aside pretax money and pay for qualified transportation.
- There’s an exception, though. Through 2026, you can deduct the cost of a qualified bicycle commuting reimbursement program. If you do, you’ll need to add the reimbursed amount to your employees’ wages, which means they may have to pay taxes on the money.
- You can only deduct 50 percent of the cost for office meals and snacks, and won’t be able to deduct any of those expenses starting in 2025.
- You’ll now need to add moving expense reimbursements to your employees’ wages. They’ll no longer be able to deduct these expenses, although there are some exceptions for U.S. Armed Forces members.
- “At one point, there was a viral (and incorrect) Facebook post saying that all deductions for business owners had been eliminated,” says Derus. “In reality, miscellaneous itemized deductions greater than 2 percent of adjusted gross income (AGI) were eliminated. That means employees (not business owners) could no longer deduct unreimbursed business expenses on their tax return.” These expenses could be for things like equipment or a work uniform.
Learn more on the IRS’s website
The IRS maintains and regularly updates a variety of guides for small businesses.
There’s an area just for small businesses and self-employed people, a breakdown of how the tax bill affects businesses, a separate overview for international taxpayers and businesses, and a side-by-side comparison that shows what the tax bill changed.
With 2018 being the first year all these changes are in play, you may want to keep an eye on these resources and the IRS news releases for additional guidance or clarification as tax season approaches.
Funding Circle believes informed consumers are better consumers. We strive to provide informative and educational content useful for you and your business. However, please note that tax laws and regulations are complex and subject to change. We strongly recommend consulting your financial or tax professional regarding your specific circumstances.