By now most of you that are small business owners have heard about some of the tax changes in the Tax Cuts & Jobs Act that was passed in late 2017 and became effective as of Jan 1st, 2018. You might have even read our previous article for self-employed tax changes.
What you may or may not know are the details of this new tax plan, or more specifically, what these tax changes could possibly mean for you and your small business in 2018. We plan to clear that up in this post for the majority of you.
Before we dive into the plan, we want you to be aware that this article is not intended as legal or financial advice and you should always seek help from a tax professional with any specific tax questions you may have.
What Is The Tax Cuts & Jobs Act?
According to the official document, “This bill amends the Internal Revenue Code (IRC) to reduce tax rates and modify policies, credits, and deductions for individuals and businesses.”
While there are many changes to the tax code that affect individuals, we’re only going to touch on the amendments that impact businesses – primarily small businesses.
What’s the TCJA going to cost? The bill is expected to add $1.5 trillion to the federal deficit over the next 10 years. That’s a lot of money the government is hoping to recoup by incentivizing small business owners like yourself to re-invest the savings into your business and growing jobs and raising salaries in the process.
Tax Act Highlights
- A 20 percent deduction for all pass-through businesses (S-Corp, LLP, LLC & Sole Proprietor)
- Married individuals who own service-based businesses can only receive the 20 percent deduction if they make under $315,000 per year or $157,500 if filing single.
- The top corporate tax rate has dropped from 35 to 21 percent.
- Equipment expenses rise from $500,000 to $1 million.
Let’s start at the top.
20% Small Business Income Deduction
The 20% deduction is the star of the show for small business. If you own a pass-through entity such as S Corp, LLC, LLP or Sole Proprietor you can deduct 20% of your gross income straight off the top.
With 1 big caveat.
If you own a service-based business you must make under $315,000/yr if filing married/jointly, or $157,500 if filing single.
Why would they add that stipulation? It’s quite simple, really. Abuse.
This tax plan was created to help small businesses through incentives, not enable loopholes so wealthy small business owners could chop another 20% off of their taxes.
Imagine how many people would take advantage of that if they could. 1 person law firms, or high-priced consultants that gross millions taking a 20% discount!
So, how does it work? Here’s an example.
Let’s say Small Business X grossed $124,293.80 this year. Under the new tax plan, Small Business X is allowed to take 20% of that number right off the top.
Now the taxable income from Small Business X is…
Original Amount: $124,293.80
Minus 20%: $24,858.76
New Taxable Amount: $99,435.04
That’s quite a savings!
The government hopes this 20% reduction in taxable income helps to funnel more of the savings back into small business, creating more jobs, pay raises & bonuses in the process.
Corporate Tax Rate (C Corporations)
While this doesn’t necessarily affect many small businesses directly, the move from a top corporate tax rate of 35% down to 21% is absolutely massive and about as controversial as you would think.
Do big corporations really need those 14% savings?
Is the substantial savings really going to help create more jobs?
These are questions that can’t necessarily be answered right now, however, this amendment was added to the plan based on the belief that some of the largest American corporations are skirting tax laws through loopholes, and foreign tax agreements and the government wants to give these businesses more incentive to keep their business (and revenue!) in America.
Furthermore, with a “low” tax rate of 21%, the hypothesis is that many foreign companies that operate under much higher tax rates would opt to relocate their business to America and take advantage of the savings.
This plan comes at a hefty short-term cost of almost $1 trillion in the next 10 years, so it’s a big bet. Time will tell if this strategy helps American’s by giving corporations, both foreign and domestic, enough incentive to keep their companies in America or relocate to the US, ultimately creating more jobs and more taxable income.
Small Business Equipment Expenses
This year, using Section 179 for deductions, small businesses will be happy to know they can take an extra $500,000 on purchases of equipment. From computers to manufacturing equipment you’ll have a total of $1,000,000 of allowable deductibles.
The phase-out deduction has been increased to $2,500,000 from $2,030,000 in 2017.
Starting in 2018, if you qualify, you’re going to see a 20% reduction on your taxable income. In addition, if you buy small business equipment you now have $1,000,000 to work with instead of $500,000.
While the plan may end up costing taxpayers $1 trillion over the course of 10 years, the hope is that these incentives bring more companies to America, and more importantly for you small business owners – allow you to re-invest in your business and grow!
To see the new personal tax rates, check out our self-employed tax changes article where we’ve included a table of the 2018 personal income tax rates. If you’re operating a pass-through entity such as Sole Prop, LLC, LLP or S-Corp, this will ultimately apply to you and there are some new changes in rates & the Standard Deduction.
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