Taxes can be confusing at the best of times, but the sweeping changes brought into effect by the 2017 Tax Cuts and Jobs Act (H.R.1) have many small business owners wondering how the new legislation will affect them and what the pros and cons are. As with all things taxation, the benefits (and disadvantages) for America’s businesses are somewhat complicated to decipher.
If you operate a pass-through entity, such as an LLC, sole proprietorship, partnership, or S corporation, one big change you’ll see is a reduction in your individual income tax rate. Pass-through entities aren’t subject to federal income tax. Instead, income is allocated among the owner(s), and tax is paid at the individual level. In this way, a pass-through entity avoids double taxation. Starting in 2018 (but expiring in 2025, unless extended by Congress), individual income tax rates will range from 10% to 37%. (Previously they ranged from 10% to 39.6%.)
In addition, the standard deduction has increased. Previously the deduction was $13,000 for a couple filing jointly; this will jump to $24,000. If you file singly, the deduction will jump from $6,500 to $12.500.
Note: The reduction in your income tax bill may be offset in certain instances by the elimination or limitation of many personal deductions.
2. 20% tax break for small businesses, aka the “Pass-Through Income Deduction”
If you own a pass-through entity, the new law allows you to deduct 20% of “qualified business income”—in other words, the income your business generates, less any applicable expenses. However, it’s not a free for all, and this deduction is subject to limitations.
In general, to qualify for the deduction your income must be below $157,500 if you're single or $315,000 if you're married and file jointly. In addition, the deduction can’t be claimed by certain service trades, such as health, law and professional services, if they’re income is over $315,00 per year.
3. Reduced corporate tax rate
Perhaps the most publicized change in the tax law is the reduction of the corporate tax rate from 35% to 21%. This permanent tax cut does not have an expiration date. But what does it mean for small businesses?
If you operate an incorporated business but haven’t elected S corporation status (known for tax purposes as a C corporation) or are an LLC whose members who have decided to tax the business as a C corporation, you will qualify for the new corporate tax rate of 21%.
Note: The alternative minimum tax on corporations was also repealed.
The bottom line
It’s vital that you work with your CPA or tax advisor to understand how the new tax law impacts your business, and the sooner the better. Together you can review both your business and personal situation and devise strategies to take advantage of the changes the law has ushered in, review your legal entity and tax status, and make decisions about the best way forward.
Tip: Keep in mind that any changes you make to your business structure – such as changing from a corporation to an LLC or vice versa - will need to be filed at the state level. The steps needed to change your entity type vary from state to state and depend on the entity you’re currently registered as and the one you wish to adopt going forward. You may also require new licenses if your structure changes. If you do business in another state other than where your business is primarily registered, you are also required to update the official records with the filing office in each foreign state.
Finally, be sure to consult the governing state statute and documents, bylaws, or your LLC operating agreement to determine the approval procedure for any changes to your business structure.
BizFilings is here to help you comply with the requirements of the relevant state business entity laws.