The recent Tax Cuts and Jobs Act purported to simplify tax structures, rates and exemptions, but accountants say small businesses face plenty of nuances depending on their size, structure and profits.
“One thing I have noticed, people thought they were going to be left with simpler tax laws and to some extent, some have,” said Sally Steffes, CPA and one of the partners at H&S Companies PC. “There are many variables to contend with.”
Steffes and other accountants recommend business owners consult with CPAs to understand how the laws affect their companies and what tax planning they should do to best reap the benefits. In general, the Tax Cuts and Jobs Act signed by President Trump in 2017 will result in regular wage earners and business owners seeing benefits when they file their 2018 tax returns.
Here are some top highlights of the tax law changes for small businesses.
The vast majority of businesses use a pass-through structure, which includes S corps, partnerships and single-member LLCs. Any net business profits flow through to the individual owner’s income tax return and tax is calculated at the owner’s individual rates.
“Basically, it allows for small businesses to deduct up to 20 percent of their business income as a deduction and not pay tax on it,” Steffes said. “There are many variables that go into this deduction.”
Since the seven individual income tax brackets have gone down by 2-4 percent, this means most small business owners will pay less in taxes. For example, eligible business owners with $100,000 of qualified business income could get a $20,000 deduction on their tax returns, subject to the numerous limitations on the maximum deduction.
However, specified service trades or businesses owned by individuals with taxable income more than $157,500 if single and more than $315,000 if married will lose some or all of the benefits of this deduction, said Daniel Harris, a CPA and senior manager at Grand Rapids-based Hungerford Nichols CPAs + Advisors.
These businesses include professions such as accountants, attorneys, doctors and some consultants, Harris said.
On average, since people have lower tax rates, small business owners and sole proprietors who make quarterly tax payments also may want to consult with their accountant to adjust those payments for 2019, Harris said.
Flat C corp tax rate
If your business is structured as a C corp, you may win or lose depending on your previous tax rate. C corps formerly paid taxes at a graduated rate scale from 15 percent to 35 percent and now it’s a flat 21 percent.
That benefits personal service corporations that were formerly taxed at 35 percent, Steffes said. A personal service corporation provides services to individuals or groups and typically applies to medical and dental practices.
However, small C corps that formerly paid tax at a rate of 15 percent will actually face a tax increase and may want to review how they are structured, Harris said.
“Now their taxes go up to 21 percent on all of their taxable income,” he said. “I am seeing companies at the lower end, with relatively little profit, that will benefit from switching to an S corp.”
Under new bonus depreciation rules, businesses can generally deduct the full cost of most fixed assets in the year of purchase rather than spreading the deduction over many years, Harris said.
Specifically, it allows for the write-off of personal property used in a trade or business that has a useful life of 20 years or less to be depreciated entirely in the year of purchase. This incentive to purchase equipment runs until the end of 2022, but it’s only a one-time deduction, Steffes noted.
The benefit will gradually decrease to 20 percent beginning in 2023 until it expires at the end of 2026.
This applies to both new and used equipment, but there are exceptions for vehicles, according to Harris. Examples include computers, office furniture, cash registers and kitchen or medical office equipment. The change took effect in 2018, meaning any business owner who spent a lot on equipment last year will see the benefit when they file their 2018 taxes.
“In general, most of what you buy for your company should be able to be expensed in one year,” Harris said. “In the past, it was 50 percent and you would gradually write off the rest in other years.”
Accrual or cash accounting
Businesses with less than $25 million in average annual gross receipts may want to consider changing their tax accounting method from accrual to cash. In some cases, this can defer a lot of income and tax into future years, according to Harris.
Under the new law, there are some exceptions but business owners can automatically convert to the cash method of accounting if they qualify.
Still, owners should consult with their tax advisers for guidance, Steffes said.
“Instead of picking up income when you invoice somebody, you’re picking up income when you actually get paid,” she said.
Other changes important to small business owners include:
AMT elimination: The new tax act permanently did away with the corporate AMT, a tax computation that ensured that C corps paid at least a minimum amount of tax.
“Some C corps have never been in an AMT position, but many have,” Steffes said. “C corps don’t have to worry about the alternative minimum tax and this is gone for good.”
Carrying losses forward: Although it hasn’t been as common in recent years, under old tax law, businesses could file a form and carry business losses back to a previous year, Harris said. That would often drive down their taxable income for that year and they could get an immediate refund on taxes previously paid. Now, business owners can only carry losses forward.
Entertainment deductions: Previously, businesses could write off 50 percent of entertainment expenses. That tax perk ended at the beginning of 2018. This means tickets for sporting events, corporate box seats, theater shows, golf and country club fees, or anything related to entertainment is no longer deductible. Businesses can still deduct client or business-related meals at 50 percent, but keep receipts and other documentation for support, Steffes said.
Because of other tax changes, including nearly doubling the standard deduction for individuals and married couples filing jointly and an increase in the child tax credit from $1,000 to $2,000, most taxpayers, including business owners, benefit from the Tax Cuts and Jobs Act, Harris said.
For small business owners, most of these tax-related benefits should come when they file their 2018 tax returns.
“It really depends upon your business and how you are operating, and how we can apply the tax law,” Steffes said. “It really is dependent on your income level and what type of business you have and how you are structured so you can determine whether this was a win for you or not.”