While there are plenty of partisan opinions regarding the Tax Cuts and Jobs Act, the tax reform, which was signed into law before the end of 2017, you might find yourself asking the same questions as many small business owners.
How does this tax reform affect my business? My employees? Me?
To help clear up the confusion, we’ll dive into some specifics about the tax reform that were signed into law, as well as address a few topics that remain at the rumor stage.
How Tax Reform Directly Impacts Your Business Taxes
Shortly after President Trump signed the tax bill into law, he gave a speech outlining the goals and key elements of the bill. Trump claimed that the tax reform will keep businesses in America, attract new businesses to America, incent businesses to better compensate employees, and enable employees to keep a greater portion of their paychecks. The key elements that the President expects to achieve these goals include:
- Corporate Tax Cuts
- Redrawn Tax Brackets
- Increased Standard Deduction
- Increased Business Deduction
- Elimination of the Obamacare Personal Mandate
How Tax Reform Affects C-Corporations
Supporters of the tax reform have touted the corporate tax cut, which has gotten the most attention in the news.
Indeed, the corporate tax rate has been lowered from 35% to 21%, for companies taxed as C-Corporations.
If you are taxed as a C-Corporation, this 14% drop could have a major impact on your bottom line. If your company enjoys this tax cut, you will end up with more money to invest back into your business and employees, or to distribute to your shareholders.
For instance, USA Today reports that FedEx will boost employee compensation, and Honeywell will increase its 401k match as a direct result of each company’s tax savings. While this is great news for companies taxed as C-Corporations, most small businesses are not taxed as C-Corporations.
How Tax Reform Affects Partnerships, S-Corporations, and Sole Proprietorships
If you are taxed as a partnership, S-Corporation, or sole proprietor, your business is not taxed directly. Instead, taxes are passed-through to shareholders and owners. The 14% corporation tax cut does not apply to businesses subject to pass-through taxation.
However, the new tax bill includes a new 20% tax deduction for small business owners who utilize pass-through taxation models. If you qualify for the 20% deduction, the deduction applies to the lesser of your qualified business income (i.e. your business income minus your business expenses), and your taxable income (minus capital gains). The deduction is applied on your personal tax return, because pass-through taxation models apply taxes at the personal income level, not the business income level. Before you start calculating your 20% deduction, make sure you are eligible.
The 20% deduction does not apply to all pass-through tax scenarios. Certain qualifications and limitations apply. For instance, caps on taxable income may prevent you from qualifying. If you are single, your taxable income must be below $157,500 (below $315,000 if filing jointly), to qualify for the 20% deduction. If you move above the thresholds, additional elements come into play (e.g. specific rules apply to certain services businesses above the thresholds). If you plan to take advantage of the 20% deduction, and your taxable income falls above the thresholds mentioned, you should visit the tax bill text directly, or consult an expert to determine your eligibility.
How Tax Reform Affects LLCs
If your business is an LLC, your business may either benefit from the 14% tax cut, or the 20% deduction, but not both. LLCs elect C-Corporation taxation, or pass-through taxation when formally filing with the IRS. You would have made this election on IRS Form 8832 when you were originally setting up your business. If you elected C-Corporation taxation on the form, your business will enjoy the 14% tax cut. If you elected pass-through taxation, the new 20% tax deduction, and limitations, apply to your your personal income tax return. While it is possible that your LLC is taxed as a C-Corporation, many businesses choose an LLC specifically to avoid C-Corporation taxation.
How Tax Reform Impacts Your Take Home Business Income
As discussed, you may be eligible for a 20% deduction on your business income. Whether you enjoy the full 20%, or something less than 20%, a new deduction for your take home business income is nice.
However, your overall personal income may also be affected by the new tax bill. For starters, the new tax bill rewrote the tax brackets. The new tax brackets not only change the tax rates, but also the income ranges applicable to the new rates.
There was considerable press and debate regarding the new tax brackets. However, much of the debate regarding whether the new brackets would negatively impact the middle class was based on the originally proposed brackets which would have consolidated the overall number of tax brackets from seven to four. The bill signed into law includes seven tax brackets, slightly adjusted in both income range and tax rate.
To see side by side changes from 2017 to 2018, and where you land in the new brackets, check out the charts below:
|Tax Rate||Income||Tax Rate||Income|
|10%||$0 - $9,325||10%||$0 - $9,525|
|15%||$9,326 - $37,950||12%||$9,526 - $38,700|
|25%||$37,951 - $91,900||22%||$38,701 - $82,500|
|28%||$91,901 - $191,650||24%||$82,501 - $157,500|
|33%||$191,651 - $416,700||32%||$157,501 - $200,000|
|35%||$416,701 - $418,400||35%||$201,001 - $500,000|
|39.60%||$418,401 or more||37%||$500,001 or more|
|Tax Rate||Income||Tax Rate||Income|
|10%||$0 - $18,650||10%||$0 - $19,050|
|15%||$18,651 - $75,900||12%||$19,051 - 77,400|
|25%||$75,901 - $153,100||22%||$77,401 - $165,000|
|28%||$153,101 - $233,350||24%||$165,001 - $315,000|
|33%||$233,351 - $416,700||32%||$315,001 - $400,000|
|35%||$416,701 - $470,700||35%||$400,001 - $600,000|
|39.60%||$470,701 or more||37%||$600,001 or more|
In addition to the new tax brackets, the tax bill changes the much-used standard deduction and personal exemption. In 2017, taxpayers could stack the standard deduction ($6,350 for single filers, $12,700 for joint filers) and a personal exemption ($4,050 for single filers, $8,100 for joint filers).
In 2018, the personal exemption has been eliminated, but the standard deduction has been increased to $12,000 for single filers and $24,000 for joint filers.
If you are in the practice of itemizing deductions, you will want to read further into the text of the bill or consult an expert. The bill changes rules and thresholds on itemizations. However, with the standard deduction more than doubling, it is expected that the standard deduction will only become more popular.
How Tax Reform Impacts Your Business Expenses
If you have operated your business through sweeping legislative changes (e.g. Sarbanes-Oxley, Dodd-Frank, Obamacare, etc.) before, you know that new legislation means new costs.
Cost #1: Research and Process Change
Specific to the tax bill, the research and process change of most interest relates to withholding tax in payroll.
In early January, the IRS released the 2018 Withholding Tables. The IRS is giving employers until February 15, 2018 to start using the new tables. The new tables reflect changes to the tax brackets, standard deduction, and elimination of personal exemption.
With the new tables, you may need to get updated W-4s from your employees. However, as of the writing of this article, the IRS has not published its 2018 W-4, and you should continue to use the 2017 version.
With the new withholding tables, employee paychecks are going to change. This leads to a second expense you might run into with the new tax bill…
Cost #2: Processing Errors
With change, comes errors. Errors on employee paychecks could be the single greatest source of contention between you and your employees. The IRS is already encouraging employees across industries to revisit their W-4s and double check their paychecks for accuracy. Researching, discussing, and remedying paycheck errors is all but certain as the new tax bill starts taking effect.
Cost #3: Managing Employee Expectations and/or Turnover
A final expense to consider revolves around employee expectations. Many businesses across the US have announced raises and bonuses directly attributed to the tax bill. For example, Walmart announced $1,000 bonuses for many eligible employees and raised its minimum wage to $11 per hour.
Other US-based businesses acting upon the tax bill include Bank of America, AT&T, Wells Fargo, Boeing, and NBC. Perhaps the tax changes will enable you to take similar action as these business juggernauts; perhaps not. Either way, your employees are seeing these grandiose announcements in the media, and managing their expectations will take effort, and expense.
Other Impacts Tax Reform Might Have on Your Business
As with any front page legislation, rumors about the impact of the tax bill include highly speculative claims from both sides of the aisle. As the tax bill begins to play its way out in the real world, it’s important to understand what remains conjecture.
First, healthcare costs have been mentioned over and over again in the media. It is true, the individual mandate to procure healthcare was removed in the tax bill. However, the only immediate effect this will have is the removal of the Obamacare-induced penalty for not having healthcare. Obamacare advocates have suggested that this will lead to millions of Americans dropping their health insurance, which will lead to premium spikes for those who continue to carry health insurance. While this may seem like a logical conclusion, whether or not millions will actually drop their coverage, and whether such dropping will lead to premium spikes are both guesses at this point.
Second, some have overplayed the potential impact of the payroll withholding confusion. Some news outlets have reported that the American Payroll Association (APA) drafted a panicked letter to congress stating that APA members (roughly 17 million American employers) regarding the withholding issues that would take effect quickly after passing legislation.
As mentioned, there is no doubt that the tax bill will cause some disruption to payroll. However, rest assured, payroll withholding is not the end of the story when it comes to paying your taxes in the ordinary course. W-4s, and other withholding taxes have always been a guessing game. The goal of payroll withholding is to estimate employees’ taxes that will become due tax day of the following year. In turn, the estimated taxes are withheld from each paycheck throughout the year. If it takes payroll and tax departments an entire year to get it right, there is always the true-up process that occurs tax season of every year. As mentioned, mistakes are inevitable, but mistakes aren’t the end of the world.
On the other side of the aisle, some have boasted of the historical impact of the December 2017 tax reform. First, “tax reform” is probably too strong of language. The tax system remains fully in place (e.g. seven tax brackets with redrawn lines, and a change to the standard deduction). The tax bill was not an overhaul to the ever-evolving US tax law labyrinth. Second, most of the changes that directly affect paychecks and tax bills are scheduled to expire in a few years. Accordingly, before accepting sweeping claims of the tax bill’s groundbreaking benefits, make sure to understand the limited nature of the changes. The tax bill is more of a tax tweak, than tax reform.
Of the President’s stated goals, there is no doubt that most employees will see large paychecks starting in February. However, whether or not the tax bill will prompt business to come to America, or stay in America, is yet to be seen. While some of the country’s largest employers have been quick to issue raises, the tax bill does not ensure that you, as a small business owner, will have such a luxury. The first step to take as a small business owner is to ensure you are complying with the new IRS policies (i.e. withholding tables, and W-4s soon to come). Next, make sure to understand the exact impact the tax bill will have on your bottom line. Once you have a grasp on the bill’s true effects, then you can consider whether you have the ability to bump pay, hire more people, or invest in new resources.