By Alan Crystal
The Tax Cuts and Jobs Act, signed into law by President Trump on December 22, 2017, will have a significant impact on small businesses. And, unlike changes to the individual tax code, which are temporary, the changes to the business tax code are permanent.
The changes include:
- Eliminating the alternative minimum corporate tax rate
- Dropping the corporate tax rate from 35 to 21 percent
- Providing a 20 percent deduction for all pass-through businesses
It’s this last change that is most likely to affect small business owners – not only in terms of cash, but also in how they set their strategies for growth.
There are a few things that small business owners should keep in mind as they adapt to the new law.
Business structure. Pass-through business owners can claim the 20 percent deduction if their taxable income is under 157,500 for single filers or $315,000 for joint filers. According to IRS analysis, more than 70 percent of small business owners had adjusted gross income below $200,000, so many would be eligible for the full 20 percent deduction for pass-through income. Pass-through entities include sole proprietorships, and some partnerships, LLCs and S-corporations. Business owners should evaluate the pros and cons of each entity type – both when they are setting up a new business and when they are considering changing entity type.
C-corporations are subject to double taxation, which means they pay tax at the corporate level and on dividends that are distributed to business owners. Under the Tax Cuts and Jobs Act, C-corporations benefit from a flat 21 percent tax rate. For those who qualify, there are also incentives to grow internationally thanks to the new “territorial” tax system, which does not tax profits generated overseas.
Investing in the business. As a result of these changes in the tax code, many small businesses will be able to retain more cash – cash that can be deployed to improve your business. Examples might include capital investments, raising employee pay, hiring more employees, research and development, and marketing and promotion.
Employee benefits. The Tax Cuts and Jobs Act eliminates a major tax requirement of the Affordable Care Act: the mandate that individuals purchase health insurance or pay a penalty. Without this mandate, insurance companies may need to raise premiums on both individuals and their employers, while passing on associated costs to the people who have health insurance. This may make it more expensive to offer health insurance to your employees.
Additionally, you will no longer be able to deduct 100 percent of the cost of food and beverages provided to employees. Instead, business owners may deduct up to 50 percent of those costs through 2025, after which you will no longer be able to deduct these costs at all. Since it will be more expensive to offer benefits like health insurance and food to employees, business owners may want to replace these benefits with other, more affordable benefits to attract talent.
Low-interest debt. In the past, interest counted as a business expense. But under the new tax law, the net interest deduction is capped at 30 percent of EBITDA for four years. Now more than ever, access to lower interest financing will be important for small business owners.
SBA loans, largely considered the gold standard in small business lending, typically offer the lowest rates for businesses. Business owners should review all financing options to determine which products are best for their tax and growth strategies.
Financial advisors. As mentioned above, the new law allows pass-through businesses to deduct up to 20 percent of income. The formula for who can deduct and how much can be complex, and depends on what type of business you run. For example, married individuals who own service-based businesses like law and accounting firms, can only receive the 20 percent deduction if they make under $315,000 per year ($157,500 if single). Given this complexity, you should consider getting advice from a tax expert on strategies to maximize your deduction.
While you are tapping into these resources, it would also make sense to take advantage of digital tools to track the financial health of your business. An Intelligent CFO platform can provide small business owners with ongoing insights into the financial health of their business.
Alan Crystal is the Vice President, Finance for San Francisco based SmartBiz Loans, the #1 online marketplace for SBA loans.