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Key Highlights of the Tax Cuts & Jobs Act for Small Business Owners
Posted by Sylvia Lagerquist, CPA
The Tax Cuts & Jobs Act is the Republican-backed federal legislation that was signed into law on December 22, 2017 by President Donald Trump. The purpose of the legislation, simply put, is to reform the federal tax code with an eye toward reducing certain top rates and generating new investment in the U.S. economy.
However, since many of these goals primarily involve changes designed to impact larger corporations as well as those investors, the impact on small business owners is potentially complicated, with some provisions providing benefits and others causing new concern. The length of the final bill as signed into law stretches to over 1,000 pages, so one thing the new law clearly did not achieve is to simplify or streamline the code for taxpayers.
This article provides a bullet-point summary of some of the salient highlights from the new law, with an eye toward the small business owner – first by examining the business side and then by examining the individual taxpayer side:
Note: In many cases, the new law uses the term “suspend” to refer to the suspension of pre-existing tax policies that are temporarily withdrawn from application during the timeframe of tax years 2018 through 2015, at which time some provisions may expire unless renewed by Congress.
- Corporate Tax Rates – Businesses that pay corporate taxes (such as “C” corps) will see their federal corporate tax rate change from a graduated rate that previously ranged from 15% to 35%, to a flat tax rate of 21% instead.
- Section 179 Property Expense Deduction – The maximum amount a taxpayer may expense for qualifying property placed in service for the tax year increases from a previous cap of $500,000 to a new cap of $1 million.
- Deduction of Business Interest – Every business with gross receipts greater than $25 mill (regardless of form) is subject to a disallowance of a deduction for net interest expenses in excess of 30% of the adjusted taxable income for the business.
- Net Operating Loss (NOL) – The two-year carry back provision that previously applied to Net Operating Losses (NOL) is eliminated.
- Meals & Entertainment Deductions – Deductions for qualified business meals remain at 50%. Entertainment deductions are eliminated.
- Family & Medical Leave Act Deduction – Employers will now be able to get a tax credit for wages they pay to employees under the Family & Medical Leave Act (FMLA), beginning at 12.5%. Employers must pay at least 50% of the normal wage.
- Accounting Basis – The cap for the election of cash basis accounting by a taxpaying entity has been increased to $25 million.
- Percentage of Completion Method (PCM) Exemption – The PCM exemption for construction-related businesses is expanded to apply to contracts where the project is expected to be completed in two years or less, and the customer is a taxpayer who meets the $25 million gross receipts test.
- Treatment of Pass-Through Entities – Under Section 199A owners of sole proprietorships, “S” corporations and partnerships can take a deduction of 20% of Combined Qualified Business Income (QBI) against taxable income. Certain specified trades or businesses are exempt from this benefit but receive alternate treatment for earnings up to $315,000 and graduated phase-out of the benefit up to $415,000.
- Definition of QBI – Section 199A defines QBI as the “ordinary” income – less ordinary deductions – that one earns from a sole-proprietorship, S corporation, or partnership. QBI does not include any wages one earns as an employee. QBI must be earned in a “qualified trade or business.”
- Increase in Standard Deductions – For individual taxpayers, standard deductions are increased to $24,000 for married individuals filing a joint return; $18,000 for heads of households; and $12,000 for all other taxpayers. These are set to be adjusted for inflation.
- Personal Casualty Loss Deduction – An individual taxpayer will no longer be able to claim an itemized deduction for an uncompensated personal casualty loss (fire, storm, flooding, etc.) unless the event leading to the loss is a Federally-declared disaster.
- Charitable Contribution Deduction – The charitable contribution deduction limitation has been raised from 50% to 60% of Adjusted Gross Income (AGI).
- Taxation of a Child’s Earned and Unearned Income – A dependent child’s earned income is now taxed under the rates for single individuals, with the child’s unearned income taxed under the rates applicable to trusts and estates.
- Child Tax Credit – The child tax credit was increased to $2,000 per child under 17, with a $500 nonrefundable credit provided for certain non-child dependents. The income level at which the credit phases out has been increased to $400,000 for married taxpayers filing jointly, and $200,000 for all other taxpayers.
- Mortgage and Home Equity Interest Deductions – The deduction for interest on home equity indebtedness is fully suspended, while the deduction for mortgage interest is limited to underlying indebtedness up to $750,000 for married filing jointly, and $375,000 for married filing separately.
- Medical Expense Deduction Threshold – The medical expense deduction threshold is temporarily reduced to 7.5% of Adjusted Gross Income (AGI).
- Alimony Deduction by Divorced Payor – The alimony deduction by divorced persons acting as payor is suspended for divorce or separation instruments after 2018.
- Capital Gains Provisions – For individual taxpayers, any adjusted net capital gain is taxed at maximum rates of 0%, 15% or 20%, each with a specific breakpoint.
- Cost of Living (COLA) Indexing to Chained CPI – All cost of living adjustments will now be indexed for inflation using the C-CPI-U (Chained Consumer Price Index – Urban), rather than the CPI-U (standard Consumer Price Index – Urban). With this change, the pace of future upward adjustments due to inflation will generally grow at a slower pace because chained CPI takes into account the ability of consumers to substitute one good for another when relative prices go up.
- Carried Interest for Partners – The receipt of a capital interest for services provided to a partnership results in taxable compensation for the recipient, except in the case where the receipt of the profits interest in exchange for services provided entitles the holder to share only in gains and profits going forward. The law now imposes a three year holding period requirement in order for applicable members of a partnership to have the benefit of their applicable funds taxed as a capital gain, otherwise it will be taxed as short-term gain at ordinary income rates.
- Repeal of the ACA Individual Mandate – The individual mandate under the Affordable Care Act (ACA) was indeed repealed under the new tax law.
- Deductions for State and Local Taxes – Taxpayers may only deduct up to $10,000 (or $5,000 for a married taxpayer filing a separate return) as an itemized deduction.
- Prepayment of State and Local Taxes – An individual taxpayer who, in 2017, paid a state or local income tax that is imposed for a tax year after 2017, may not claim an itemized deduction in 2017 for that prepaid income tax.
- Miscellaneous Itemized Deductions – All miscellaneous itemized deductions subject to the 2% of AGI floor are suspended.
This review has only touched upon a few key highlights and provisions from the new Tax Cuts & Jobs Act, and the points we have covered here are presented only in summary form. Now is the time to speak with your CPA in detail about the new Tax Cuts & Jobs Act and its impact on your tax situation, both for your business itself and for you as an individual taxpayer.
Image credit: The White House (Flickr @ Creative Commons)
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