Tax Reform: How it Impacts Small Business Owners

Late last year President Trump signed a new tax law. This law creates the biggest overhaul of U.S. tax code since the 1980s. Here are the changes that will have the greatest impact for business owners with less than $10 million in sales.

C Corporations – The tax rates changed from four brackets ranging 15% to 35% to a flat rate of 21%. For corporations with less than $50,000 of income – they will experience a tax increase of 6%.

For other types of businesses, the changes are more complicated. Majority of small businesses are taxed as pass thru entities. This includes sole proprietors, partnership and S corporations. In all cases, the business income is taxed on the business owners’ personal tax return.

Here are the simple changes that affect all taxpayers, with or without a business:

  • Standard deduction increased from $6,350 to $12,000 for individuals and $12,700 to $24,000 for married filing joint. For many this will simplify their return.
  • Changes in Itemized deductions
    • State income taxes and real estate taxes are limited to $10,000.
    • Employee expenses, tax preparation and investment fees are no longer deductible.
    • Personal exemptions are gone.
    • Individual health insurance mandate – repealed as of January 1, 2019.
    • Alternative minimum tax has higher thresholds, so fewer taxpayers will pay AMT.
    • Individual tax rates – we still have 7 brackets ranging from 10% to 37%. We keep the 10% and 35% bracket; however, the other five brackets drop 1% to 3%, along with higher thresholds. For majority this alone will bring income taxes down.

Here is the complicated element that has a very direct impact on small business, the pass thru deduction –

  • The basic formula is simple: you subtract 20% of your qualified business income or 20% of your taxable income, whichever one is lesser, from your taxable income.
  • However once you exceed $157,500 for single and $315,000 of taxable income for married the rules get more complex. There is a phase out process as income rises up to $207,500 and $415,000.
  • Once over the phase out brackets – a few things can happen.  If the business is a specified service business – no tax deduction. If not then the tax deduction calculation takes another detour. We take into consideration 50% of the wages or 25% of the wages plus 2.5% of unadjusted basis of qualified property.

This is a very high-level description of the new “pass thru deduction”. The tax code has provided more buzzwords.  We are still working on definitions, running numbers and determining the best options to maximize the new tax law to allow business owners to decrease taxes and reinvest in their business.

As we have been working the math, comparing 2017 taxable income under the new tax rules, most business owners have seen a reduction in taxes. Majority of this tax reduction is due to the pass thru tax deduction and the lower tax rates.

One final note – entertainment deductions are now not tax deductible. So no more Packer tickets, golfing or concerts shared with a customer will be tax deductible. Customer lunches are still deductible.  Again, we are still looking for more clarification.

Note THIS IS NOT TAX ADVICE. Each situation is unique and without the full picture, results can be the opposite of your intentions.

Please consult your tax professional or contact us for a “Tax Reform Review”. We can run a projection of your 2018 tax situation with the new laws and update your current tax strategy to fit your long-term goals. Prices start at $500 – and go up based on the complexity of your situation. Call 920-351-4842 and talk to Mary to discuss your situation.

By Mary Guldan-Lindstrom, CPA

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