- The new 20% deduction for pass-through businesses can be taken by small business owners who earn less than $157,500 for individual filers and $315,000 for those who file jointly.
- If you provided transportation fringe benefits for your staff, such as parking privileges or public transit passes, they are no longer 100% deductible.
- A net operating loss is when your deductions exceed your income for the year. This is called an NOL year, and small businesses can now only carry this deduction forward, not backward, and deduct it from their income on another year.
With the new year upon us, many small business owners are turning their attention to taxes. Since Congress passed the biggest tax reform legislation in over 30 years on Jan. 1, 2018, many small business owners will find that this legislation affects their taxes for the 2019 tax year.
The tax bill modified the federal income tax brackets, doubled the standard deduction and altered several other tax credits. The original bill, The Tax Cuts and Jobs Act, was initially introduced in the House of Representatives in November 2017 and signed into law by President Donald Trump on Dec. 22, 2017.
Many revisions have since taken place, and while most are generally positive for small businesses, five major changes, in particular, might impact your small business as you prepare to file your tax return for 2019.
1. Lower tax rates
Who doesn't like lower tax rates? The tax rate for small business pass-through entities (such as S-corporations, limited liability companies, partnerships and sole proprietorships) used to be the same as your individual tax rate.
With the change in tax law, though, that income is now subject to a 20% deduction instead. As with most tax law provisions, there are exceptions to taxable income levels: $157,500 for individual filers and $315,000 for those who file jointly.
Anyone whose income is below $157,500/$315,000 can take that deduction; however, service providers need to be vigilant. "Once taxable income exceeds those thresholds, the law places limits on who can take the break," said Jeffrey Levine, CPA, director of financial planning for BluePrint Wealth Alliance. "For instance, entrepreneurs with service businesses – including doctors, lawyers and financial advisors – may not be able to take advantage of the deduction if their income is too high."
There is no distinction in tax rates based on business size, according to Calloway Cook, president of Illuminate Labs. "The federal corporate tax rate in the U.S. is 21%, and the state corporate tax rate varies by state," Cook told business.com.
Cooks says that if filed correctly, many online businesses will be able to take advantage of the home office tax deduction. "This deduction entitles the business owner to $5 per square foot of the home which is used in an office capacity," Cook said.
2. Entertainment expense
The tax law changes have also removed entertainment expense deductions. This is across the board, affecting sole proprietors, LLCs, S-corps and C-corps. While many small business owners weren't buying skyboxes or funding weekend golf trips, even the little things are no longer exempt.
The law no longer allows any kind of deduction for the following:
- Membership dues to a club for recreation or social purposes
- Any activity considered amusement, entertainment or recreation
- Use of a facility for any of the above purposes
This even extends to meals. Most meals were deducted in relation to IRC Section 274(a), related to entertainment expenses.
Author, CPA, and attorney Mark Kohler observes in a blog post that this will have a profound effect on the cost of doing businesses. "Do you know how much business is transacted on the golf course, in the skybox or over a mud bath at the spa? As a tax professional, I'll tell you – a lot! What happened to courting a new client and trying to get to know each other a little before closing the big deal? Entertaining is a huge part of doing business," wrote Kohler.
3. Higher bonus depreciation
This has always been a tricky one. What you could take as an upfront depreciation on real estate or equipment has changed nearly every year, with a percentage upfront and then the rest applied over the next few years. Tax reform has simplified this, with 50% upfront in 2017 and 100% every year thereafter. The bonus depreciation percentage is reduced for property placed in service after 2022.
The IRS states that the 100% bonus depreciation "generally applies to depreciable business assets with a recovery period of 20 years or less and certain other property. Machinery, equipment, computers, appliances and furniture generally qualify." It also applies to used equipment, not just new, as long as it meets other requirements listed in the provision.
4. Impact on benefits for employees
Every business owner wants to do what they can to make their employees feel appreciated. Tax law used to support that, but not as much anymore. If you provided transportation fringe benefits for your staff, such as parking privileges or public transit passes, they are no longer 100% deductible.
The transportation benefit has been repealed completely. If you have onsite eating facilities for your employees, the deduction has changed from 100% to 50%. It is still tax-free for your employees to use.
5. Net operating losses
A net operating loss is when your deductions for the year exceed your income. This is called an NOL year; small businesses used to be able to deduct it from their income on another year. It exists to provide some tax relief for small companies. This means when you make money, you pay taxes, and if you didn't make any money, then you can get some tax relief.
"While companies themselves can't get a tax break if they're pass-through entities (like sole proprietorships, partnerships and S-corporations), their owners can apply their net operating losses on their personal income tax returns," said Jennifer Stinnett with SmartAsset.
Under the old law, you could carry an NOL back two years or forward for the next 20 years. With tax reform, businesses can no longer use an NOL retroactively for two years, but the 20-year limit has been waived, and you can deduct up to 80% of the applicable taxable income.
Overall, Cook believes that the GOP's Tax Cuts and Jobs Act is a net benefit to most small businesses. "The only businesses under this law which will see an increase in tax rate are those making less than $50,000 profit, which is a very small percentage of businesses even at the local level," Cook said. "Cutting corporate taxes allows businesses to reinvest, which increases the chance of business success."