The Tax Cuts and Job Act: How the Trump Tax Plan Will Affect Your Small Business
What is the Tax Cuts and Jobs Act?
A small business is defined as firms that employ fewer than 500 employees and they comprise over 99% of all firms in the U.S. with employees.
The Tax Cuts and Jobs Act was signed into law by President Trump on December 22, 2017, claiming to be the largest single-time reduction in corporate tax rate in the nation’s history. The TCJA is a thick sheaf of widespread tax reform legislation that is intended to encourage employers to give back to their employees and stimulate economic growth with more businesses and jobs. One of the largest changes included slashing taxes from 35% to 21% on big businesses, a permanent change, unlike the other changes related to small business.
The TCJA also lowered taxes for small business owners and, through a number of other changes, it will have a significant impact on small business in America. Taxes on most “pass through” companies (LLCs, S corporations, partnerships, sole proprietorships) were reduced by 20%. They’re called “pass throughs” because the expenses and revenues of the owners’ businesses are passed through to their individual tax returns. However, not all pass-through entities are small businesses, so that much-discussed cut is benefitting big businesses as well.
Other features of the plan include:
- Deductions are greatly limited in the plan, down to $10,000 in state, local and federal income taxes, where previously state and local tax deduction was unlimited.
- The mortgage interest deduction decreased from $1 million in mortgage loans to $750,000.
- A tax cut for high-income earners, which lowers the rate and raises the threshold
- Larger child tax credit for working class families, which is also refundable.
- The TCJA also eliminates the health insurance mandate, so Americans are not required to have health insurance. Effective in 2019, if they don’t have health insurance, they will no longer be penalized.
- The estate tax threshold was doubled, so the amount that Americans can pass on to heirs without being taxed increased from $5.5 million to $11 million — and that threshold doubles for married couples ($22 million).
Overall, while small businesses (and tax paying citizens) will pay lower taxes, the TCJA is a mixed bag. For example, in 2025, the 20% tax reduction for pass-through businesses, and all the individual tax cuts will expire.
The full text of the act, also referred to as H.R. 1, can be found here.
What’s considered a small business under Trump’s tax plan?
What exactly is a small business? It depends on who you ask. The Small Business Administration has an official classification of small businesses by industry -determined by size or income- where even some businesses with 1,500 or fewer employees, like some types of mining companies, as well as automobile manufacturers, and airlines, qualify as small businesses. The SBA’s table of small business size standards is linked here.
The pass through companies getting the 20% deduction of their qualified business income are what people are considering small businesses in terms of the TCJA. Determining which businesses qualify for the 20% tax reduction on pass-through companies might be a more compelling question, and it’s one that may continue to be hashed out in the courts for years to come. In an attempt to prevent high-earning business owners from taking the break, the verbiage on who can’t get the deduction —such as financial service providers, performing art and consultants— wasn’t precise enough and caused confusion.
Top 6 changes for small business taxes in 2018
Understanding the new tax act is complex work, but here are some of the most-talked about features and changes.
- 20% deduction for all pass-through businesses. This applies to partnerships (businesses owned and operated by two or more parties who share responsibility for debts), sole proprietorships (businesses owned and run by one person who is personally responsible for its debts), LLCs (companies in which the owner or owners are not liable for company’s debt), and S Corporations (a corporation with 100 shareholders or less that is taxed as a partnership). This change expires in the year 2025.
- Some business deductions are no longer available. For small business owners, that means no more deductions on entertainment expenses, travel costs or dues for professional organizations. Employee transportation benefits for public transit riders and bike commuters -as well as employee parking- are also no longer deductible.
- Some business deductions are reduced or more difficult to take. Under the new act, certain deductions are reduced, like employee meals, which moved to a 50% deduction when it was originally a 100% deduction. Net operating loss (NOL), which is a loss that happens when a business’ allowable tax deductions exceed its income, was allowed to be carried back for two years and carried forward 20 years, offsetting taxable income. Now that two-year carryback is repealed, which started this year, businesses may not use NOLs for offsetting future taxable income. In addition, the deduction is reduced to 80% of taxable income, so this deduction can no longer be reduced to zero tax liability.
- Family leave credit. This is a temporary feature through 2019 that pays a credit to companies when they pay wages for family or medical leave. It ranges from 12.5 to 25%.
- Changes in accounting methods. Intended to simplify matters for small business, the accounting method reform increases gross receipt thresholds. Once those thresholds are passed, businesses must use one of the following methods for accounting: accrual basis, Section 263A inventory capitalization, percentage of completion, or account for inventories. By raising that threshold, a reduced amount of small businesses are burdened with the expense and trouble of introducing new accounting methods.
- Large-purchase write-offs. With the expansion of Section 179 filing, business equipment such as heavy machinery, ovens or computers up to one million dollars, can be deducted the first year instead of depreciating. Previously it was $510,000 and could only deduct 50% the first year. That may not make a huge difference for lower-cost equipment, but it can be a huge difference if you’re spending millions of dollars on equipment.
Additional considerations under the TCJA
Administrator Linda McMahon of U.S. Small Business Administration (SBA) issued a statement in favor of the TCJA, calling it “a reform that will be welcomed by small business owners.” The National Federation of Independent Business (NFIB) also welcomed the lower tax rates and simplified code.
C-corporations are taxed twice, while the smaller ones are only taxed once, bringing more benefit to big corporations instead of small corporations.
Although it was intended to simplify taxation, the Tax Cuts and Jobs Act is a complex plan that’s hundreds of pages in length. Not all changes of the act will apply to your small business and some of the new ones won’t exist forever. Speak to an accountant or small business tax expert to better understand how the TCJA will affect your business.