Hey small businesses and startups! I’m sure you’ve heard a thing or two about the grand tax reform and it may have left you a bit more shell shocked than ready for action. The reform made some of the biggest changes we have seen in the history of our tax code. It simplified individual tax, but it doesn’t appear to have done the same for small business. Although, that does not mean it’s absent of some heavy-hitting benefits.
As a business owner, understanding these changes and benefits can feel about as easy as swimming through mud. As your priority lies in working and growing your business (and not mastering the foreign language of tax code), here is the five-minute version of the top five changes impacting you this next year.
1. Deduction for Qualified Business Income
This one has received the most attention for small business in the new tax code and for good reason. It is by far the biggest potential game changer for small business.
Previously: All of an owner’s pass-through income would be taxed at the individual’s standard tax rate.
Now: Basically, it allows 20% of your income from a pass-through entity (sole-proprietorship, partnership, s-corp, and some LLCs) to be free from tax. Of course there are restrictions, limitations, and flaming hoops you must jump through, but this is a big win for businesses that qualify. An entire blog could be written about how this one alone is calculated (like this one, and this one, and this one).
Impact: Very positive for some, neutral for others
2. Limits on Business Interest Deduction
Have you had average revenues of at least $25 million over the past three years? Then this one is for you. Everyone else, skip on to the next one as this will not apply to you (at least not yet ).
Previously: Any interest from debt taken for trade or businesses could be fully counted as a business expense (and therefore would reduce the income subject to tax).
Now: For entities exceeding the $25 million in revenue threshold, interest expense now has a cap: 30% of EBITDA, which is another crazy accounting acronym for your business earnings before you subtract out your interest, taxes, depreciation, and amortization expenses.
Impact: Negative for some, neutral for others
3. Limit on Losses (NOLs)
Previously: Individuals could use business losses to offset their nonbusiness income (i.e. interest, dividends, and capital gains) without limitation and could carry it back 2 years and forward for the next 20 years to offset income.
Now: Beginning in 2018, the amount of business loss you could, as an individual, use to offset nonbusiness income is limited to $250,000 ($500,000 for married filing jointly) per year. Any loss beyond that limit is now carried forward indefinitely to offset income in future years and cannot be carried back. Unused or “excess” loss amounts have an additional limitation once carried forward: they can only be used to offset 80% of the taxable income in the future year it is applied.
Impact: Mostly negative: limits the loss, but can be carried forward indefinitely
4. Immediate Expensing of Capital Purchases (Machinery, office equipment/furniture, computers, software, etc.)
Previously: Companies had two tax break opportunities for capital purchases: IRC Section 179 and Bonus Depreciation. With Section 179, you were allowed to immediately expense (i.e. 100% depreciation) up to $500,000 of qualifying property in a given year and you would be phased out when more than $2 million of property was placed in service. After Section 179 would be applied, Bonus Depreciation could be used to expedite depreciation for brand-new equipment at 50% of the cost in the year purchased.
Now: The limits for Section 179 have been raised to $1 million and $2.5 million, respectively. Bonus Depreciation has been increased to 100% and now includes both new and used purchases.
Impact: Very positive, especially for growing companies that require capital equipment for expansion
5. Corporate Tax Rate Drop
One of the major headlines for business in the tax reform was the drop in the corporate tax rate to a flat 21%. It may surprise you that this is the last point I make in the list and for good reason: it actually is not highly impactful to your business unless you are already taxed as a c-corp. Making the designation change is more of a long-term strategic move than a short-term tax benefit. This is why: c-corps face double taxation, first on the corporation’s profits and second at the individual shareholder level on dividends paid by the corporation. If the company is not planning to pay out dividends and instead wishes to retain profits to reinvest in the business for a long-term strategy, a c-corp conversion may be beneficial. Unfortunately, the process to convert in the state of Arkansas is not as streamlined as most and you will have to pay in both time and money (consulting lawyers and accountants), so make sure to weigh the benefits. Finally, keep in mind that the lowering of the tax rate may not be permanent as Democrats could retake a Senate majority and vote through changes to the law.
Impact: Positive for c-corps and investors in publicly traded companies, neutral for others
This article contains general legal information and does not contain legal advice. Startup Junkie is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.
Megan Frohardt, CPA
Megan is an Executive Consultant at Startup Junkie. She leverages her master's in Accounting and MBA to assist clients by creating financial projections, cash flow analyses, pricing strategies, and financial budgets, ensuring startups launch on the right foot on all things accounting related. When she's not crunching numbers, she's likely outdoors running, hiking, or kayaking through the Ozark mountains.