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Tax Reform Means Small Businesses Need to Revisit Old Tax Strategies

by
Sherri Hastings
on
5/9/2018
Tax Reform Means Small Businesses Need to Revisit Old Tax Strategies

It’s not a surprise that the recently passed tax bill has created significant change. Hailed as the most significant reform in the last three decades, some of the law’s most notable impacts are those impacting business owners, who suddenly find themselves wondering exactly what they need to do to be sure that they are still pursuing the smartest tax filing strategies for their interests. Many will learn that it is time to reconsider the type of business entity that they are organized under, while others will want to shift their entire compensation cloud.  If you’re not confident as to how or whether tax reform will affect you, now is the time to meet with your tax advisor so that you can put new tactics in place as soon as possible.

The economy is moving in the right direction, and that’s good news for everybody, but small businesses continue to struggle in the face of the mounting costs of employee benefits, including health insurance, and changes to the nation’s tax code have only added to their burden. Many essential tax benefits have been either changed or lost entirely, and it is difficult for a small business owner to keep up with all of these shifts while also paying attention to their daily operations. 

Some of the major takeaways from the passage of the 2018 Tax Cuts and Jobs Act (TCJA) will provide small business owners with benefits, including a cut in their tax rate. But that advantage may be offset by the 30% of adjusted taxable income limit that has been placed on the amount of deduction that can be taken for interest that the business pays. Small businesses will also be hurt by the loss of their deduction for entertainment expenses incurred for business, and though they will still be able to deduct 50 percent for meal expenses incurred during business travel, they are losing the full deduction that they could previously take on their employees’ meals in situations where providing them was most convenient. Now that deduction has been cut in half to 50 percent. 

Though these changes represent a shift, the most notable change that the TCJA will make for small businesses has to do with the fact that pass-through entities are now able to take a 20 percent deduction. This will effect pass-through businesses, in which the business’ income gets reported on personal tax returns belonging to the owners rather than on a business tax return. This can apply to any type of entity other than a C corporation, including S-Corps, partnerships, sole proprietorships, rentals and farm activities.

This change was designed to make things more even for these other types of entities after the TCJA gave C corporations a dramatic tax decrease from a 35 to 21 percent rate. Though opponents to the corporate tax cut argued that this was a giveaway for corporations, proponents of the bill point out that since corporations get taxed on both their tax return and their shareholders returns, the corporate cut brings corporations into a more reasonable level of taxation, shifting the amount that corporate income could be taxed from a high of 58.8 percent down to a maximum of 44.8 percent. Though it is still the highest rate, it now comes closer to the previously established 39.6 percent top individual tax rate.  

Though some pass-through business owners have the potential of lowering their tax liability through the 20% drop, the qualified business Income deduction does have some significant limitations on who can take advantage of its benefits. Business owners who are “high income” taxpayers will find the deduction limited if the business falls into a category classified as proving a “specified service reliant on the skill or reputation of one or more of its employees.”

These specified services can include medical or law professionals, accountants, performing arts professionals and others. This means that when an individual earns more than the threshold amount $157,500 or a married couple with a joint return reporting taxable income above $315,000 will see their new tax break phased out, and altogether eliminated once their income hits the phase-out cap of $207,500 for individual taxpayers or $415,000 for those whose tax status is married filing jointly.

If these changes are confusing to you or have left you uncertain as to whether your current organizational structure is still the right one, you’re not alone. There will be many small business owners shifting from sole proprietorships to S-Corps and S-Corps shifting to C corps in order to maximize their tax strategy. To make sure that you are positioned in the most advantageous way, contact your tax professional.

Tim Murphy, CPA writes for TaxBuzz, a tax news and advice website. Reach his office at [email protected]. 

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Sherri Hastings

Sherri Hastings

Tim Murphy is the managing member at Murphy & Murphy, CPA, LLC, a full-service certified public accounting firm, with emphasis on tax preparation, audits of governmental, educational, and non-profit entities, retirement planning, estate planning, business valuations, litigation support, and banking. He is a Certified Public Accountant in Maryland and Virginia. Tim is also a CERTIFIED FINANCIAL PLANNER professional, Personal Financial Specialist, Accredited Estate Planner, Certified Valuation Analyst, and Investment Adviser Representative.

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