The monumental new tax law signed late in 2017 – the Tax Cuts and Jobs Act (TCJA) – has been hailed as a boon for big business. But the TCJA also benefits many small businesses while presenting new obstacles. In general, the revised rules for businesses take effect in 2018 and are permanent, unlike most changes for individuals. Following are the key provisions likely to affect small businesses.
Corporate taxation: The graduated tax rate structure for corporations, featuring a top tax rate of 35%, is being replaced by a flat rate of 21%. As a result, the overall tax liability of many C corporations will be reduced. Furthermore, cash accounting was generally not available to corporations with average gross receipts for the three prior years of $5 million or more. This rule has been replaced by a $25 million gross receipts test.
Section 179 deductions: Under Section 179 of the Internal Revenue Code, a business could expense up to $500,000 of the cost of qualified business property, subject to a dollar-for-dollar phaseout above $2 million. These figures were indexed for inflation. The new doubles the maximum allowance to $1 million and increases the phaseout threshold to $2.5 million. Caveat: The maximum allowance is still limited to the amount of income from business activity.
Bonus depreciation: In recent years, the percentage for first-year “bonus depreciation” deductions has fluctuated, complicating tax planning. Now the new law hikes the bonus depreciation deduction from 50% to 100% for five years and then gradually phases out the deduction over the next five years. Added bonus: The deduction has been expanded to include “used” property that otherwise qualifies under this provision.
Luxury car deductions: The annual depreciation limits for “luxury cars” kick in at surprisingly modest levels, Now the new law hikes the limits for business drivers for cars placed in service in 2018 and thereafter. For instance, not even counting bonus depreciation, the first-year deduction jumps from $3,160 to $10,000. Of course, actual deductions must be based on percentage of business use.
Pass-through entities: The net income of pass-through entities like partnerships, S corporations, limited liability companies (LLCs) and sole proprietors is effectively taxed at individual tax rates. Now, for the first time ever, the new law creates a 20% deduction on income for pass-through entities, subject to certain limitations. Notably, the deduction only applies to “qualified business income” and can’t be claimed by taxpayers in service businesses (excluding architecture and engineering) for single filers with taxable income above $157,500, and $315,000 for joint filers.
Other deductions and credits: Finally, the new law includes a slew of other changes affecting deductions and credits commonly claimed by businesses. For instance:
In particular, planning may focus on the new deduction for pass-through entities. These rules are so complex even tax experts are having trouble sorting through them, but some clients may be tempted to shift the form of business ownership or transfer ownership shares to other family members to cash in on this tax break.
Expect the IRS to issue guidance on the new deduction for pass-through entities and other aspects of the new tax law affecting small businesses. We will continue to update you on significant new developments.
Contributed by Ken Berry, J.D. – CPA Practice Advisor Correspondent