How the Trump Tax Plan Will Affect Your Small Business

Whether you’re an accountant, business owner, or average citizen in the United States, unless you have the ability to freeze time, you likely have one thing on your mind until April 17. And that’s taxes. Especially now that the new Trump tax plan could impact small business, there are more unanswered questions than ever.

The IRS’s tax code is complicated as it is, and small businesses often have trouble understanding their own business tax records and liability. Now, with all of the tax code changes recently passed into law, how will the new Trump tax reform plan affect small businesses?

Officially called the Tax Cuts and Jobs Act, Trump’s tax reform plan—and all of the legislation that led up to its passage—has been the subject of much discussion since it was signed into law. The new tax code sets into motion new deductions and credits that will affect each small businesses’ tax liability differently. And what’s most important is that those changes have already kicked in.

So, as we’re already barreling headfirst into tax season, business owners and business accountants are scrambling to figure out how the Trump tax plan will impact small business. Although you won’t be able to calculate the exact dollars and cents until you go through your financials line by line with your tax team, this breakdown should really help you understand the impact of the new tax plan on your small business.

First: How Is Your Small Business Structured?

That’s the most important question when you’re trying to figure out how the Trump tax plan will impact your small business. The way you’ve structured or incorporated is extremely important, since it’ll determine the deductions and credits you’re eligible for under the Tax Cuts and Jobs Act.

To understand how Trump’s tax plan will impact your business, let’s first re-establish the different categories of businesses entities at the center of Trump’s tax plan:

• C-Corporation (C-corp): This is a corporation that’s a separate legal entity from its owners. A C-corp can make profits, be held legally liable as an entity unto itself, and is taxed separately. Unlike LLCs, partnerships, and sole proprietorships, C-corps are taxed both at the corporate level (Form 1120) and then again at the personal income tax level if corporate income and payments are distributed to the company’s shareholders.<
  

• S-Corporation (S-corp): This is a corporation that’s structured to avoid the double taxation of C-corps. S-corps benefit from pass-through taxation—essentially, business owners report their profit and loss on their individual tax returns to avoid being taxed twice.
  

• Sole Proprietorship: This is a business that has no legally separate existence from its owner. That means that all income and losses are taxed on the individual business owner’s personal income tax return.
  

• Limited Liability Company (LLC): This is a company that consists of one or more people. In this business structure, owners are not personally liable for the company’s debt, and taxes are passed through to the business owners.

Different Trump Tax Plan Benefits for Various Small Business Structures

The new tax plan brings a slew of new deductions, new tax credits, and tools that small business owners can take advantage of to reduce their tax burden.

Decreased Corporate Tax Rate for C-Corps

Perhaps the most widely debated change is that the Trump tax plan cuts the corporate tax rate. Under the Tax Cuts and Jobs Act, C-corps are taxed at a flat rate of 21%—a cut from the previous range of 15%-35%.

How does a change in the corporate tax rate impact small businesses, especially if this tax break applies specifically to C-corps?

While this is a high profile component of Trump’s tax plan, most small businesses aren’t structured as C-corps. The majority of US small business are pass-through entities, such as LLCs or S-corps. So, although some small businesses are affected, this change mostly impacts Fortune 500 companies rather than small businesses.

Pass-Through Deduction

That does mean, however, that these businesses might be affected by the new pass-through deduction. The main difference that distinguishes a pass-through entity from a C-corp is how taxation is handled (hence, why we’re talking about it). So, rather than paying income taxes as a totally separate entity, the pass-through entity passes the profits and losses through to the owner. The business owner then reports that as personal income. (See, it’s passed through.) In that way, as the government sees it, the finances of the owner and the business are pretty intertwined.

The absolute biggest thing you need to know is that under Trump’s new tax plan, small businesses that are filing as pass-throughs can take a 20% business income deduction.

To qualify for this 20% deduction, business owners must have a taxable income of below $157,500 if single or $315,000 if married and filing jointly. So, if your business is structured as a sole proprietorship, partnership, LLC, or S-corp, you could qualify for this pass-through deduction of 20%.

The deduction doesn’t lower your adjusted gross income, and you aren’t required to itemize on your taxes in order to take it. If you do qualify, a 20% deduction will be applied to whichever is lower—your qualified business income (the ordinary income of the business), or your taxable income minus capital gains.

A much simpler way of putting it: If you’re an owner of a pass-through entity, you’ll now be able to shave 20% off your earnings before paying taxes on it. But there’s always a catch, isn’t there?

Unfortunately, there’s a big one here. If your pass-through business generates revenue through the professional services of one individual—think doctors, lawyers, accountants, and consultants, for example—you’re not eligible for the deduction. However, if you are a sole proprietor operating outside the field of professional services (e.g. you sell goods), you’d be eligible to take the deduction.

Bigger Write-Offs for Big Expenses

A new provision of Trump’s tax plan lets businesses write off a larger portion of large equipment purchases up front, instead of depreciating them over a number of years.

These changes are part of a tax-saving tool called bonus depreciation. It sounds more complicated than it is: Basically, when your business buys a new piece of equipment, you typically can write it off a little at a time each tax season. This is a new tax deduction that lets you write off the entire cost of that equipment purchase for the year you bought it.  This way, you can spread out the cost of an asset you purchase and use for business over a number of years (like a car) until you either recover the cost of the asset or stop using it.

Bonus depreciation used to only cover new equipment purchases—but under Trump’s tax plan, it’ll cover all equipment that’s still in use. Previously, businesses were only able to deduct up to $510,000 in equipment purchases. Under the new tax plan, business owners can deduct up to $1 million in equipment purchases. If you’re thinking, That’s a big difference! well, yes, it is.

How do these new equipment deductions from the Trump tax plan affect your small business? Under the new tax plan, you can deduct 100% of the cost of an asset in the year you buy it, whereas previously you were only able to take 50% of the value.

In addition to increasing the percentage of value you can deduct, the new law lets you take the deduction over five years, whereas previously it was only eligible in the year the asset was placed in service. The deduction has also expanded to include used or old equipment—anything as big as a building or as small as a computer.

So, if you’ve purchased new equipment, a new vehicle, or snapped up any new real estate since September 2017, this element of the Trump tax plan benefits your small business. You can write 100% of the cost for that off this year.

Repealed Corporate Alternative Minimum Tax

The Alternative Minimum Tax (AMT) is a tax tool designed to make sure that large corporations don’t take too many deductions and avoid paying taxes. The Trump tax plan repealed the corporate AMT, which helps guarantee that businesses can reap the benefits of the new tax cuts.

Essentially, the AMT is a separate way of calculating your tax liability. Every business is required to calculate its tax burden in two ways: the normal way for corporate income taxes and, again using this other method, the AMT. Most tax software will automatically make both of these calculations for you. Once those two calculations are made, the business must pay whichever is the higher of the two tax burdens.

Figuring out the AMT is pretty complex, but the only thing you really need to know is that you don’t have to figure it out anymore at all. There is no longer an AMT to calculate for small businesses. So, if you feel like you’re finding deductions and exemptions that make your business’s tax burden easier, ride the wave—there’s no alternative calculation to hold you back!

The repeal of the AMT, while contested in the House and Senate versions of the bill, was met with excitement by the business community. Keeping it in place would get rid of a lot of the benefits of lower tax rates for businesses, because it guarantees that businesses pay a certain rate regardless of the deductions they take.

Updates to Accounting Methods

The Trump tax plan lets more companies take advantage of the cash method of accounting, rather than the accrual method. Using the cash method of accounting, revenue is recorded as soon as the cash is received from customers, and expenses are recorded as soon as they’re paid to suppliers and employees. That’s different from the accrual method, in which revenue is recorded when it’s earned and expenses are only recorded when consumed.

The time difference is the important part—under the accrual method, business owners could get stuck waiting until they sell inventory to deduct the cost of it, rather than being able to deduct it when they make the purchase.

Generally, manufacturing businesses are required to use the accrual method, but the new tax plan raises the annual revenue threshold from $5 million to $25 million, drastically increasing the number of businesses that can qualify for an exemption from that rule.

That’s a huge benefit for any manufacturing businesses and for any small businesses that deal with inventory. And here’s why: Accrual accounting requires that income and expenses be booked when they are owed, rather than when they are paid or received. It can be costly to figure out the value of inventory—especially for small businesses who operate in volatile markets where pricing is always fluctuating.  

Trump’s tax plan relaxes the requirements around using the accrual method. Under the new law, businesses with an average annual revenue of $25 million or less are exempt from the requirement, meaning they can use the cash method. That’s up from $5 million under the previous tax code.

The takeaway here? Many more small businesses will now be able to deduct inventory when they pay for it, rather than needing to wait until that inventory is sold. However, it’s important to remember that the accrual method has its value too, especially when it comes to business forecasting.

Family Leave Credit

The Trump tax plan also creates a new credit for wages paid for family or medical leave. The intention of this tax credit is to encourage employers to pay when their employees need leave—something that can be tough on small businesses. Depending on the amount of wages paid out, the tax credit can range from 12.5% to 25%.

This part of the Trump tax policy isn’t permanent, though. Since it only lasts through 2019, make sure to take advantage of it and provide that leave for your employees! Everyone will benefit!

Changes Within the Trump Tax Plan That Could Negatively Impact Small Businesses

Although the new tax plan brings several new credits and increased deductions to incentivize things like investing in new equipment and providing family leave, Trump’s Tax Cuts and Jobs Act also removes some benefits and tax tools that small business owners used to take advantage of across all sectors.

With that in mind, it’s important to remember that each industry will be affected by changes to the tax code differently. Some of these tax changes could impact your small business by increasing your tax burden:

Repealed Deductions

Business Interest Deduction

The business interest deduction was an important part of the prior tax code that helped out business owners who took out small business loans to cover relevant operating costs. The interest on those business loans would be deductible as an ordinary business expense.  

While the business interest deduction wasn’t fully repealed in the Trump tax plan, it was significantly decreased, which might drive small business owners’ taxes up from years past.

Under the Trump Tax plan, the business interest deduction is cut to 30%. That’s a long way from before, when the business interest deduction wasn’t restricted at all. This’ll impact the way small businesses file taxes this season because they can now only deduct an interest expense of up to 30% of their business’s EBITDA (earnings before interest, taxes, depreciation, and amortization).

While this mostly impacts companies with a taxable profit, like C-corps, small businesses that have a lot of debt on their books should be especially conscious of this change. But it’s not all bad news: If your small business has an annual average gross receipt of $25 million or less for the past three years, you’re in luck—your business is exempt from this rule.

The Controversial Section 199 Manufacturing Loophole

Trump’s new tax plan got rid of a deduction that was commonly claimed by manufacturing businesses, called the Section 199 deduction. This was one of the biggest loopholes cited by critics of the former tax code. For example, if a company assembled, say, a gift basket onsite, even if the basket comprised fully pre-manufactured goods, the gift basket company could claim the controversial Section 199 deduction.

Section 199 allowed business owners to take a 9% deduction on income from qualified production activities, with the intention of incentivizing domestic manufacturing in the U.S. Manufacturing firms can no longer claim this benefit because it was repealed in this tax bill.

Deduction for Entertainment Expenses

Any business owner in client service is familiar with the dynamic of wining and dining a client. Sports games, dinners, drinks—all of that entertainment is fun, but pricey. At the same time, it can often be the best way to attract new business, so the tradeoff is often worth it. Especially if you could write it off come tax season.

Prior to the Tax Cuts and Job Act, business owners could deduct up to 50% of expenses they’d paid for business-related entertainment. No more: The new tax plan does away with deductions for entertainment expenses entirely.

Unfortunately, that means a lot of business owners are going to have to start paying taxes on things like box seats and dinners out with clients. Or drop them from their business plans entirely.

Deduction for Providing Employee Meals

Another employee perk that used to be deductible were employee meals. Now, if you feed your staff on business premises, that food that was formerly 100% deductible under the former tax law is now only 50% deductible. By 2025, it won’t be deductible at all.

Deduction for Transportation Expenses

This one is pretty straightforward—and one that a lot of small business owners are going to miss. Under the new Trump tax plan, business owners can no longer deduct the cost of providing employee parking, public transportation passes, and bike commute reimbursements.

What Other Impacts Can Small Business Owners Expect to Feel from the Trump Tax Plan?

As with most complex legislation, you can expect the impact of Trump’s tax plan on your small business to be a mixed bag. That’s especially true for an overhaul like this, which completely rewrites many aspects of the tax code. You’ll probably end up finding that some things that may benefit your small business directly, especially if you’re a pass-through entity, and that other pieces, like deductions you’re used to taking, have disappeared.

The most important thing to do to stay informed about how Trump’s tax plan will impact your business is to speak to your accountant. Keeping open those lines of communication with your tax team will help you find out which new credits and deductions you can take advantage of this year, and in the years to come.

These chats might even change the way you do business—like implementing new family leave policies, strategies for tracking inventory, or accounting methods!

Things to Think About As You Do Business Under the New Tax Code

1. The best way to invest in your workers.

You might have noticed that as a reaction to corporate tax cuts, U.S. businesses are giving out bonuses to at least 3 million workers across the country. Moving forward, small business owners have an opportunity to determine how much their tax burden will change, and evaluate the best way to invest any potential savings into their businesses.

Bonuses are just one way to do this—owners can also pass this money to their workers in the form of other structural investments, such as wage increases. Business owners should definitely weigh the impacts of giving a one-time bonus versus a permanent wage increase, since these will definitely impact their teams differently.

2. Temporary versus permanent code changes.

Although these changes to the tax code kick in immediately, not all of them last forever. Some provisions expire as early as 2019, and others last through 2025. Some have also been instituted in perpetuity.

Again, you’ll need to talk to your accountant (sensing a theme here?) for the most accurate advice—and especially the kind that pertains to your specific industry, and you personally.

3. The impending deadline to reclassify.

Most immediately, small business owners should keep an eye out for the March 15 deadline to consider entity classification. Is your business set up the most advantageous way? Since this will impact the way you file your taxes and the credits/deductions you will be eligible for, this should be top-of-mind.

The goal of widespread tax cuts are to help empower businesses to invest in their employees and growth. If you’re a small business owner trying to determine the impact of the Trump tax plan, take advantage of all of the small business tax information resources available to help you along the way!

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from Fundera Ledger https://www.fundera.com/blog/trump-tax-plan