By John Milikowsky
The Tax Cuts and Jobs Act (TCJA) is the largest change to the U.S. tax code in 30 years and affects each and every American. As a responsible tax-paying business owner, you need to be aware of how these changes will affect your business taxes so that you can plan ahead for the coming tax season.
It’s not just the business tax changes that may impact you. The removal of individual deductions can affect your employees, prompting some small business owners to renegotiate how they handle smaller reimbursements.
The most celebrated change is the lowered corporate tax rate, but that’s only one small part of the whole package. It’s wise to speak with a tax professional now to get personalized advice for the upcoming tax season.
Here is a list of things you should discuss with your CPA.
1. QBI Deduction For Pass-Through Entities
If you are self-employed, have an S-corp, or have a partnership, your business is considered a pass-through entity, and you may be eligible for a 20% qualified business income (QBI) deduction — a complex new deduction that spans 10 pages within the final bill. You should discuss the full details with your own CPA, but here are the basics.
Income from large C-corporations is double-taxed — the corporation pays taxes and then the individuals pay taxes again. Pass-through entities only get taxed once, usually about 10% less than C-corporations. The TCJA has reduced the C-corp tax rate significantly, which killed a major advantage of having a pass-through entity. Thus, the new QBI deduction rule gives small business owners further advantages.
Though this new deduction appears to be a great opportunity for all business owners, the catch is in the word “qualified.” Not all business income will apply and some types of businesses are excluded entirely. Employees, interest, and investment income all affect the amount of income that is eligible for the deduction. The rule may encourage some small businesses to hire more people, as hiring more staff generally makes it easier to qualify for this deduction.
Depending on your circumstances, you may find it more beneficial to refile yourself as a C-corp than to remain as a pass-through entity for tax purposes, as crazy as it sounds. Such big steps should be done with the aid of a tax professional who can assess whether you’ll save money in the long-run. For a business entity conversion, you’ll also need the help of a business lawyer to make the conversion and help you to understand the consequences.
2. Your Employees’ W4s
Personal and dependent exemptions are excluded from 2018 through 2025. This means that your employees’ taxable income amounts may increase greatly. You should prepare to explain to your employees how their taxable income will change under the new rules so they aren’t caught off-guard. They also may want to update their W4s.
Fortunately, the standard deduction will nearly double and the child tax credit has received a major overhaul. You may still end up paying less in taxes despite the increase in taxable income, but be prepared to negotiate compensation packages with some employees who may have gotten the short end of the stick.
An employee may approach you with an offer to work as an independent contractor (with a 1099) instead of as an employee (with a W-2), as there’s often confusion about which role has a better tax situation. If you aren’t used to working with independent contractors, be extremely cautious. Hiring independent contractors can be beneficial, but there are some very significant differences between the two that, if not handled properly, can plague your business with penalties.
3. Disappearing or Modified Deductions
Although the TCJA increases the standard deduction, many business deductions are either getting phased out or completely removed for this year. If they’re not careful, sole proprietors and partnerships may get caught off-guard.
Here are a few deductions that are going away or getting heavy modifications:
- Miscellaneous itemized deductions subject to the 2% AGI limitation
- Personal casualty and theft losses — except in declared disaster areas
- Moving expenses
- Business meal and entertainment deductions
- Certain kinds of donations if you receive goods/services in return
You may need to adjust your reimbursement programs for employees who’ve relied on those deductions as a means of compensation. There are many small details, so seek professional advice on which deduction eliminations may impact your business and your employees. The removal of miscellaneous itemized deductions covers a host of tiny deductions that, when taken in total, can create a sizeable increase in your taxable income.
4. Equipment and Property Deductions
If your business has been considering a large equipment or property purchase, this may be the best time to do it. Previous tax years had a maximum deduction of $510,000 for these types of purchases, but that limit has now been raised to $1 million. For property, the bonus depreciation is increased to 100%, though this will be phased down slowly after 2022.
Most small businesses won’t approach these limits at all, but for businesses with expensive equipment — such as farms or manufacturing companies — this deduction may save you a significant amount of money. Small businesses contemplating the leap up to a new office space or an IT overhaul might use this deduction to make it worthwhile.
For full details on how these deductions work, visit the official website on Section 179.
To avoid being surprised when tax time comes around, speak with a business tax professional who understands the new changes. The sooner you can understand how your taxes and deductions will need to shift, the sooner you can adjust your budget and your compensation packages to meet the new tax reality.
John Milikowsky represents U.S. and foreign businesses and individuals in sophisticated business transactions involving U.S. tax matters. Mr. Milikowsky relentlessly defends each client in federal and audits and criminal investigations to protect their civil rights and provide financial securstate ity.