How Will the New Tax Plan Impact Your Small Business?

Tax reform is still working its way through Congress, but its final form has become more clear as both the House and Senate have released the full text of their bills. Here are the most important changes that will impact small businesses.

Changing Tax Brackets

Both corporate and individual tax rates will change under the new plan. For corporations and LLCs taxed as corporations, the maximum tax rate will drop from 35 percent to 20 percent.

Individual income tax rates, which are imposed on sole proprietorship and partnership income, would drop from a maximum 39.6 percent to 35 percent under the House plan. The remaining brackets will also be consolidated into fewer tiers and shifted. This will result in lower taxes for many individuals, but those at the top of a bracket may see their marginal rate increase.

Changing How Passthrough Entities are Taxed

One downside to sole proprietorships, partnerships, and S-corporations has been that income is often taxed at higher personal tax rates (plus Social Security and Medicare taxes) rather than potentially lower corporate tax rates. This problem would be further magnified by nearly halving the maximum corporate tax rate, but the House and Senate both offer solutions.
The House plan creates a safe harbor where a pass through entity’s owner can automatically treat 70% of business income as wages taxed at their individual rate and 30% as business income taxed at the new corporate rate. Capital-intensive businesses may also be eligible to increase the business income portion.
The Senate plan leaves pass through income at the personal rates but adds a deduction to offset the added taxes. Small business owners will be able to subtract 17.4% of their business income from their taxable personal income.

Removal of Itemized Deductions

Although individuals may see their taxes go up if they’re currently itemizing their deductions, there will be no changes on the business side. Ordinary and necessary business deductions remain deductible directly on Schedule C for sole proprietors or on the business tax return for other entities. These deductions have and will continue to be considered expenses of the business and not itemizable personal deductions.

Replacing Depreciating with More Expensing

Currently, high-value assets, such as vehicles and machinery, must be depreciated over time to spread the tax deduction over the life of the asset. The new rules would allow a much broader range of assets to be expensed immediately, thereby allowing business owners to deduct the full cost of the asset in the year of purchase.

Revisiting Healthcare

The Senate has put eliminating the Obamacare mandate back on the table as it debates its version of the bill. While this provision currently has weak support, it could mean that small businesses would no longer be fined if they were unable to afford to offer health coverage for their employees.

Elimination of the Estate Tax

One final change to keep an eye on is the elimination of the estate tax or a large increase in the estate tax exemption. This change would allow families who have a substantial portion of their net worth in a multi generational business to avoid having to take off debt or sell shares in the business to pay estate taxes on the business’s value.

When to Take Action

Any part of the bill is subject to change until the final vote, so the best thing you can do right now is to stay informed and run spreadsheet forecasts on how the changes will impact you. The most important thing to remember is that any changes would be for your 2018 tax return. That gives you the rest of 2017 to take any deductions or credits that you may lose when the final version passes.

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