Small businesses account for 99.7% of U.S. employer firms. Needless to say, any development that impacts small businesses is worth paying attention to.
Enter the Tax Cuts and Jobs Act (TCJA).
Passed in December 2017 and effective (for the most part) on January 1, 2018, this act is a universal development and affects small businesses plenty. In fact, it might just be the largest rewrite of the U.S. tax code in decades.
The Tax Cuts and Jobs Act was designed to make the tax code simpler. However, “simple” can be a relative term. There’d be no shame if you thought you could use a little help clarifying what it actually means for small businesses—as well as owners, employers, employees, vendors, families, and everyone else affected by small businesses.
Of course, the best-known tax change is the corporate tax rate being lowered from 35% to 21%. But that doesn’t necessarily cover what’s happening for small businesses.
So what does it mean for them?
1. Section 179 Deductions (Business Equipment Expensing)
Previously, businesses could expense up to $500,000 of business costs qualifying under the Internal Revenue Code, with a dollar-for-dollar phaseout starting at $2 million.
The Tax Cuts and Jobs Act has doubled the expense deduction to $1 million, with a phaseout at $2.5 million. That means the purchase isn’t capitalized and depreciated; it’s treated as an expense for tax purposes.
Note: this figure is still limited to the amount of business income.
So what property qualifies under Section 179? Here are some examples:
- Equipment purchased for business use (such as machines)
- Personal property used in business (it has to be tangible)
- Business vehicles with a gross vehicle weight over 6,000 lbs (Check out Section 179 Vehicle Deductions for more info)
- “Off-the-shelf” software for computers
- Office furniture
- Office equipment
- Property that’s attached to your building but not a structural component (e.g., a 3D printer, a printing press, any large manufacturing equipment and tools)
- Equipment purchased for business use as well as personal use (partial business use). Generally, this deduction will be based on the percentage of time the equipment is used for dedicated business purposes.
2. Lower Tax Rates for Individuals
90% of small businesses are pass-through entities—sole proprietorships, partnerships, or S-corporations. In those cases, the business itself isn’t taxed; the owners are taxed according to their individual income tax rates.
(The rules change depending on the income and specific business type.)
The Tax Cuts and Jobs Act’s lower tax rates mean a direct tax liability reduction to pass-through principals.
3. 20% Business Income Deduction
The 20% business income deduction found in section 199A is yet another tax reform element that could help small business owners pay even less in taxes.
It won’t reduce AGI, nor is it included in itemized deductions. It will, however, directly reduce your taxable income. It’s available as a deduction from taxable income as reported on Form 1040 for individuals or Form 1041 for trusts and estates.
So how does it actually work? Well, generally speaking, it allows you to deduct an amount equal to 20% of your qualified business income (QBI), qualified REIT dividends, and qualified publicly traded partnership income. However, that’s a bit more complicated than it sounds.
So what is QBI?
- QBI is the net amount of domestic income, deductions, losses, and gains for the taxable year from a qualified trade or business (QTB) allocated to you based on your ownership percentage. That’s typically the bottom-line taxable income from your Schedule C or Line #1 from your S corporation or partnership, but it can vary.
- QBI includes neither guaranteed payments received from your partnership nor reasonable compensation from your S corporation. This means that W-2 wages from your S corporation or guaranteed payments from your partnership aren’t an addback to the QBI from your trades and/or businesses.
As for what constitutes a QTB or what rental activities qualify for the 199A deduction, well that’s where the bulk of the complexity is. Making these determinations requires an in-depth analysis of your particular situation, which makes tax planning more important than ever.
4. Bonus Depreciation
Bonus depreciation has expanded from 50% to 100%. The eligible percentage then phases out over the next five years. This means, much like the Section 179 deduction mentioned above, you may be able to expense your capital purchases all in the year these items are acquired; however, unlike the Section 179 deduction, bonus depreciation is not limited to business income (it can create or increase a loss). But Tennesseans beware! Unlike the Section 179 deduction, bonus depreciation is not allowed for purposes of the Tennessee Excise Tax; thus, you may have a loss for federal purposes but still have taxable income for state purposes.
There’s another bonus to this one, too: this now includes “used” property (that otherwise qualifies), which was previously ineligible.
5. Luxury Car Deductions
This one may not end up being exercised as much as others, but it’s still worth noting.
This first-year deduction was previously $3,160 but has now been increased to $10,000. Of course, it’s still ultimately based on how much the vehicle is actually used for business. TheTax Cuts and Jobs Act also retained the additional $8,000 first-year depreciation limit, making the maximum expensing for passenger automobiles and light trucks/vans, $18,000 for 2018.
6. Net Operating Losses
The Tax Cuts and Jobs Act has revamped the rules for net operating losses (NOLs).
The long and the short of it is that NOLs can’t be carried back for two years anymore. They can, however, be carried forward indefinitely now, instead of the previous 20 years.
Note: this is now bound by a limit of 80% of taxable income.
7. Repealed Deductions
The Tax Cuts and Jobs Act means the repeal of a few previous deductions.
- The Section 199 deduction for qualified domestic production activities (this deduction was claimed by manufacturing firms the most)
- Entertainment expenses directly related to or associated with conducting the business
- Transportation fringe benefits (note: if employers provide these benefits, they stay tax-free to employees)
And while not a repeal, per se, the Tax Cuts and Jobs Act does reduce the deduction for any on-site eating facilities (e.g., cafeterias) from 100% to 50%. Then, in 2025, it will disappear completely. But this fringe benefit remains tax-free to employees.
All of these small business-related items have rules applying to them, and this post doesn’t cover everything you might want to know.
We’d recommend you see a tax professional for advice instead of trying to wing it on your own. A seasoned professional can help you pick out the best strategies and tactics for you and your business.