The Tax Cuts and Jobs Act (H.R. 1, “TCJA”) has is now law. The law contains many provisions affecting both individuals and small businesses. The main provisions affecting businesses are summarized below. Except where otherwise noted, these changes apply to after January 1, 2018. Thus, they do not apply to your 2017 taxes and your upcoming tax return.
What’s The New Corporate Tax Rate?
The cornerstone of the TCJA is a new lower rate for regular C corporations. C corporations are separate taxpaying entities with their own tax rates. Under the TCJA all C corporations are subject to single flat tax rate of 21 percent. The previous tax rates ranged from 15 percent to 35 percent.
New Pass-Through Tax Deduction
The vast majority of smaller businesses are not organized as C corporations. Instead, they are “pass-through entities.” This includes sole proprietorships, limited liability companies, partnerships, and S corporations.
These entities pay no taxes themselves. Instead, the profits from such businesses are passed through and the owners pay tax on them at their individual tax rates. These rates can now be higher than the 21 percent rate for C corporations-under the new tax law.
The TCJA creates a brand new tax deduction for individuals who earn income through pass-through entities. Such individuals may be eligible to deduct an amount up to 20 percent of their net business income. This is in addition to all their other business deductions, like mileage or a home office deduction.
If this deduction applies, a passthrough owner is effectively taxed on only 80 percent of business income. Thus, the effective rate for passthrough owners in the top 37 percent tax bracket is 29.5 percent.
This is a personal deduction passthrough owners can take on their returns whether or not they itemize. This deduction is scheduled to end on Jan. 1, 2026.
How Does The Pass-Through Tax Deduction Work?
This complex deduction works as follows:
Income Below $315,000 ($157,500 For Singles):
A passthrough owner qualifies for an income tax deduction equal to 20 percent of net passthrough income if he or she:
- Operates the business as a sole proprietor, LLC owner, partner in a partnership, or S corporation shareholder and
- Total taxable income for the year from all sources after deductions is below $315,000 if married filing jointly, or $157,500 if single.
This deduction is phased out if income exceeds the $315,000/$157,500 limits. It disappears entirely for marrieds filing jointly whose income exceeds $415,000 and for singles whose income exceeds $207,500.
Income Above $415,000 ($207,500 For Singles):
If a passthrough owner’s annual taxable income from all sources after deductions is over $415,000 if married filing jointly, or $207,500 if single, you may still get the deduction. Yet, the deduction cannot exceed:
- 50 percent of the owner’s applicable share of the W-2 employee wages paid by the business, or
- 25 percent of the owner’s share of the W-2 wages paid by the business, PLUS 2.5 percent of the original purchase price of the long-term property used in the production of income.
Who Benefts From This Pass-Through Deduction?
Since many owners of pass-through businesses have no employees, the 25 percent plus 2.5 percent deduction will be of most benefit to them. The 2.5 percent deduction can be taken during the entire deprecation period for the property. Yet, it can be no shorter than 10 years.
What About Services-Oriented Small Business Owners?
Special rules apply to passthrough owners whose business involves providing various services. Some of these include:
- actuarial science
- performing arts
- financial services
- brokerage services
- investment management
- trading and dealing in securities or commodities
- any business where the principal asset is the reputation or skill of one or more of its owners
- Engineers and architects are not included
A service business owner can take the 20 percent passthrough deduction only the taxable income from all sources after deductions is less than $315,000 if married filing jointly, or $157,500 if single. The deduction is phased out if income exceeds the $315,000/$157,500 limits.
It disappears entirely for marrieds filing jointly whose income exceeds $415,000 and for singles whose income exceeds $207,500. Service passthrough owners whose income exceeds the thresholds are not entitled to the 50 percent of W2 employee or 25 percent of W2 employee plus 2.5 percent of business property deduction.
What About Bonus Depreciation?
Bonus depreciation allows you to deduct a substantial amount of a long-term asset’s cost in the single year instead of depreciating it over years. Prior to the new tax law, the bonus depreciation amount was 50 percent. That is, 50 percent of the cost of an asset could be deducted the first year, with the remaining cost deducted over several years.
The TCJA increases the bonus depreciation amount to 100 percent. The increase goes into effect for long-term assets placed in service after September 27, 2017. For the first time, bonus depreciation may be used for purchases of used as well as new business property.
The 100 percent amount is scheduled to remain in effect until Jan. 1, 2023. In later years, the first-year bonus depreciation deduction amount goes down, as follows:
- 80 percent for property placed in service during 2023
- 60 percent for property placed in service during 2024
- 40 percent for property placed in service during 2025
- 20 percent for property placed in service during 2026, and
- 0 percent for property placed in service after 2016.
You must use listed property over 50 percent of the time for business to qualify for bonus depreciation. Computers were classified as listed property under prior law, but the TCJA changes that starting in 2018.
Thus, bonus depreciation may be used to deduct computers used less than 50 percent of the time for business in 2018.
Automobile Depreciation Limits
There are annual limits on how much you can depreciate on passenger automobiles used for business. The TCJA increased these limits to:
- $10,000 for the first year the vehicle is placed in service
- $16,000 for the second year
- $9,600 for the third year
- $5,760 for the fourth and later years.
Bonus depreciation for automobiles placed in 2018 remains at $8,000. Thus, the total allowable 2018 depreciation for an automobile is $18,000, by far the most it has ever been. This deduction may only be taken if you use the actual expense method to deduct your car expenses.
The $1 Million Section 179 Expensing
Under prior law, Section 179 allowed business owners to deduct up to $510,000 of the cost of personal property they used for business in a single year. This assumes they used it for business over 50 percent of the time.
The new tax law increased that amount to $1 million. The $1,000,000 amount is reduced (but not below zero) by the amount by which the cost of property placed in service during the year exceeds $2,500,000.
Limits on Deducting Business Interest
Larger businesses, those with average gross receipts of $25 million or more, are not be allowed to deduct interest payments in excess of 30 percent of their taxable income. Any interest amounts disallowed under the provision would be carried forward to the succeeding five taxable years.
Businesses with gross receipts less than $25 million are not subject to this restriction and may continue to deduct all their interest payments.
Limits On Deducting Net Operating Losses
A business has a net operating loss (NOL) if its expenses exceed its income for the year. Under prior law, if a business had an NOL, it could be carried back two years.
The new tax law eliminates carrybacks of NOLs. That is, they may only be deducted in current and future years. Additionally, taxpayers are allowed to deduct NOLs only up to 80 percent of taxable income. Unused NOL amounts may be carried forward and deducted in any number of future years.
Elimination Of Certain Deductions And Credits
The new law also eliminates various business tax deductions and credits, including the:
- Deduction for business entertainment expenses, except for meals
- Starting 2026, the deduction for meals provided to employees for the convenience of the employer
- Deduction for payment of employee parking, mass transit, or commuting expenses
- Domestic production activities deduction, and
- Deduction for local lobbying expenses.
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