5 Things Small Business Owners Need to Know About the New Tax LawIt's time again for everyone's favorite springtime activity: filing taxes.
Changes to the tax code can impact your small business far into the future, and this year, companies of all sizes and types are facing new rules.
“There is not one single type of entity that is impacted by the new laws. All entities are effectively receiving tax cuts across the board,” said Matthew Foster, CPA and senior tax manager for accounting firm Frazier & Deeter. “All entity types get to take advantage of some of the beneficial tax changes, such as the 100 percent bonus depreciation, and all entities are subject to the new limitations in deductions such as meals and entertainment.”
To find out more, NCR Silver asked Foster and Brandon Hayes, vice president of oXYGen Financial, about what small business owners need to know.
Qualified Business Income Deduction (QBID)
“For small business that are sole proprietorships, partnerships or S corporations, the biggest change will be the Qualified Business Income Deduction (QBID),” said Foster.
These entities (along with LLCs) are considered “pass-through businesses” by the IRS, meaning the owner books company profits on their personal income, instead of filing business taxes separately. The QBID is a 20 percent deduction of a taxpayer’s qualified business income from these business types.
“This effectively makes the income from those entity types taxable at 29 percent rather than the individual max rate of 37 percent,” he said.
This new deduction, however, comes with a number of rules designed to discourage high-income taxpayers from trying to exploit the system for a higher tax break, so be sure to talk to your CPA to see if your business qualifies.
Expanded bonus depreciation
According to the IRS, bonus depreciation lets taxpayers deduct more depreciation in the year the qualifying property was placed in service, thus increasing your tax compensation up-front for new business assets and depreciating a smaller amount over time.
Under the new law, Hayes said, extremely large expenses for business equipment can be deducted in the first year— up to 100 percent, through the year 2022.
“The new rules also make it acceptable to apply the 100 percent bonus-depreciation rules on used property, where before the assets had to be purchased new to qualify. This can be a huge incentive for businesses to expand operations and improve facilities,” Foster added.
Net Operating Loss (NOL)
A lot of small businesses incur losses, especially in their early years. To mitigate some of the pain as entrepreneurs are getting established, the IRS created the tax attribute “Net Operating Loss” or NOL.
“Under the new laws, NOLs are no longer available to carryback to prior years to claim refunds, but instead can be carried forward indefinitely. The caveat is that the NOLs that are carried forward can only offset 80 percent of taxable income, whereas under old law, taxpayers were able to offset, in some circumstances, 100 percent of their taxable income,” Foster explained.
Interest expense limitations
If your small business has accrued significant debts, you may feel the impact of a new deduction limit for interest expense.
“Under new law, the deduction for business interest for any tax year cannot exceed the sum of (1) the taxpayer’s business interest income for the year and (2) 30 percent of the taxpayer’s adjusted taxable income for the tax year,” said Foster.
While limits are never fun, there is a bright side, he said.
“Any amount of interest that cannot be deducted during the tax year is carried forward indefinitely until it can be deducted. This rule was put into place to prevent shifting of income between related taxpayers, also known as earnings stripping.”
Reduced tax rate for corporations
While the majority of small businesses are pass-through entities, some owners still choose to incorporate — and these companies may see the biggest difference on their tax bill. Rates for C corporations transitioned from a graduated system to a flat rate of 21 percent for tax years starting with 2018.
“For the majority of C corporation businesses, this will result in greater tax savings and more cash staying within the company,” Foster explained.
According to Hayes, if a C-corp was paying $70,000 in taxes, this year they only have to pay $42,000 in taxes. “That’s a 40 percent difference in cash that can be deployed to other places than to pay taxes to the IRS,” he said.
The caveat is that C-corps with lower taxable income could pay more taxes under the new system, said Foster. Before, under the graduated system, the tax rate for businesses with less than $50,000 in taxable income was 15 percent.
So what now?
“As it is with all new changes to the tax law, please consult your personal CPA,” advised Foster. “The new laws will have a significant impact on small businesses and how they do business over the next several years. Now is the time that all small business owners should consult with their CPA prior to any major business decision. Methods and structures that were used before, may not function in the same manner now.”