On January 1, Congress enacted the Tax Cuts and Jobs Act with the goal of creating jobs and helping American businesses grow and prosper. But just how much your business stands to benefit depends on how it’s run and organized. We sat down with Dan Routh, tax partner at RSM US LLP — a leading provider of audit, tax and consulting services — to get his take on the changes.
Here’s a look at seven reforms that could impact your business — and your bottom line, according to Routh:
1. A Reduced Corporate Tax Rate
The 2017 Tax Act permanently reduces the corporate tax rate from 35 percent to a flat 21 percent for tax years beginning after December 31, 2017. The upshot is that corporations will pay less tax and have more money to invest back into their businesses.
Who’s Affected? Corporations
2. A Pass-Through Business Rate Deduction
A business not incorporated as a corporation is considered a “pass-through” entity, and income generated by such a business may be “passed through” to the business owner’s tax return. Prior to the 2017 Tax Act, this income was taxed at the same rate as other income. Going forward, until this change expires December 31, 2025, qualifying taxpayers may claim a 20 percent deduction on pass-through income. “There isn’t any reduction of tax rate,” explains Routh, “but there is a reduction of tax because business owners are essentially paying tax only on 80 percent of their business income with the new pass-through deduction.”
Who’s Affected? S corporations, partnerships, sole proprietorships and limited liability companies and partnerships (LLCs and LLPs). Businesses must meet certain criteria for income, wage payments and depreciable business assets. Taxpayers with pass-through income from specified service businesses — those in which the business’ principal asset is the reputation or skill of one or more employees or owners — are ineligible for the deduction.
“In most contexts, the corporation gets reduced taxes via the reduction of the tax rate, and the S corps and LLCs get reduced taxes through the new pass-through deduction that was created,” says Routh. “So, pretty much all qualified businesses should pay less tax when you look at just the rate reduction changes.”
3. 100 Percent Expensing for Business Assets
The 2017 Tax Act allows immediate and full expensing for qualified property placed in service after September 27, 2017 (e.g., equipment, computers, office space, etc.). Previously, businesses could deduct only 50 percent of the cost of the purchase immediately, depreciating the rest of the expense over the useful life of the purchase. Additionally, used equipment will qualify for 100 percent expensing, whereas it formerly did not qualify at all.
Who’s Affected? Any business purchasing qualified business assets
4. Cash Method of Accounting
Effective for tax years beginning after December 31, 2017, taxpayers with average gross receipts of less than $25 million (indexed for inflation) for the prior three taxable years are permitted to use the cash method of accounting, regardless of entity structure or industry. Previously, corporations and partnerships with corporate partners were prohibited from using the cash method of accounting unless they met an average gross receipt of less than $5 million for the prior three taxable years. Generally speaking, the changes will allow more businesses to defer paying taxes on income they’ve yet to receive.
Who’s Affected? Businesses reporting taxable income under $25 million.
5. Net Operating Losses
The 2017 Tax Act limits the net operating loss deduction to 80 percent of taxable income. In addition, the 2017 Tax Act eliminates carrybacks and allows unused losses to be carried forward indefinitely. Previously, a taxpayer could claim a net operating loss deduction for 100 percent of taxable income. Taxpayers were also allowed to carry losses back two tax years and/or carry them forward for 20 years. Under the new terms, cash-strapped businesses will have to pay more immediate outlays, but they’ll be able to carry losses forward longer.
Who’s Affected? Unprofitable businesses (i.e., those with deductible expenses exceeding revenue) that have become profitable.
6. Limitation on Business Interest Expense Deduction
The 2017 Tax Act limits the deduction for net interest expenses incurred by a business to 30 percent of the business’s adjusted taxable income. Previously, businesses could deduct whatever they paid the bank in interest (for financed equipment, for example) — thereby lowering taxable income and, in some cases, even creating a net operating loss. Under the new law, companies with a lot of debt and interest expense may find themselves paying more taxes due to their interest expense deductions being limited. The good news is that disallowed interest can be carried forward indefinitely.
Who’s Affected? Highly leveraged businesses (Businesses with average annual gross receipts of $25 million or less are exempt from the limit.)
7. Entertainment Expenses
The 2017 Tax Act eliminates the deduction for expenses related to entertainment, amusement or recreation. The deduction for meals offered to employees as a convenience to the employer is now limited to 50 percent. Previously, a taxpayer was allowed a deduction equal to 50 percent of business-related meals and entertainment expenses and a 100 percent deduction for meals offered to employees as a convenience to the employer.
“The general thinking is that the true business meal won’t be impacted,” says Routh. “Taking clients out to lunch will still be 50 percent deductible. But taking clients out to a baseball game is now going to be 100 percent non-deductible.”
Who’s Affected? All businesses
Lower Taxes = More Money to Invest in Your Business!
Here are a few ideas to get you started:
– Upgrade tools and equipment
– Service or replace fleet vehicles
– Increase paid lead flows
– Automate administrative and field service processes
– Enhance your online marketing efforts
– Hire and/or train new employees