Small businesses' many new tax considerations, plus some tax tips, to celebrate Small Business Week 2018
Happy National Small Business Week 2018.
OK, technically it started yesterday, Sunday, April 29, and runs through Saturday, May 5. I like that it's a full seven-day week, not just a Monday-through-Friday work week since most small business owners are on the job way more than the traditional five-day, 40-hour weeks.
This week has been celebrated annual since 1963 as a way to recognize the contributions of U.S. entrepreneurs and small business owners. According to the U.S. Small Business Administration, more than half of Americans either own or work for a small business and they create about two out of every three new jobs in the country each year.
One of the major concerns for all businesses, but particularly smaller ones, is taxes. And while the recently enacted Tax Cuts and Jobs Act (TCJA) was designed to alleviate some of the tax concerns of large companies, smaller businesses also see some benefits.
An infographic from Small Business Trends, excerpted below (click it to see the full image), offers an overview of the small business components in the new tax law.
If you prefer text, here are some highlights.
Different businesses, different tax cuts: As noted earlier, the corporate tax rate is now a flat 21 percent. This is a permanent (as far as that word can be applied to anything Congress does) change.
Additionally, there is no Alternative Minimum Corporate Tax starting in 2018.
Then there are the tax rules for businesses that operate as pass-through entities. These companies don't file separate tax returns, but rather the earnings and expenses are passed through (hence the name) to the owner(s) and reported on their personal tax returns.
Pass-through companies will get a 20 percent deduction of qualified business income. This is the bottom line profits from your business, that is, the all business revenue less all business expenses.
This 20 percent write-off, formally known as the new Internal Revenue Code section 199A deduction, is a temporary tax law change that expires at the end of 2025. It was created to reduce the effective top rate on pass-through business income from the new top 37 percent top individual income tax rate.
While many small businesses operate as pass-through entities, they are not the only beneficiaries of this new deduction. As I noted in my earlier post on pass-through problems in the GOP tax reform bill, there are around 25 million pass-through companies in the United States and they're not necessarily all small businesses.
This has led many to see the TCJA as unfairly skewed toward big business, even more so than in just its permanent reduction of the corporate tax rate.
And that lower permanent corporate rate has created another business tax question. If you already operate a pass-through business, with C corps now getting the lower 21 percent tax rate would it be more tax beneficial to consider incorporating?
Importance of business entities: That incorporation question underscores one thing that hasn't changed under the TCJA. How your business is taxed at the federal level is based on your business' structure.
The most common business entity options and what they mean to your federal taxes are:
- Sole proprietorship. Here a business owner does not file a separate tax return, but rather reports business income and expenses on his/her personal Form 1040 via Schedule C.
- Partnership. This is an association of two or more persons to carry on a business. It can take different forms, such as limited or general partnerships. Partnerships file a separate return (Form 1065) and pass the income or loss to each individual partner, who then is responsible for reporting the information on their tax returns.
- Limited Liability Company (LLC). An LLC is not a separate tax entity, but instead, for tax purposes, a pass-through entity. An LLC is a state designation and is selected as a way to offer personal liability protection for its owners. States typically impose a fee for forming an LLC and some continue to collect an annual tax or fee on the entities as long as they are active. At the federal level, an LLC is basically treated as a hybrid tax entity depending on how many members are part of the entity. Uncle Sam can tax it as a partnership, a corporation or, in the case of a one-member LLC, as a what the IRS calls a disregarded entity. In the disregarded entity case, the solo LCC member does not file a separate federal tax form. The single LLC owner simply reports income and expenses on Schedule C, which is filed with the individual's Form 1040, just like a sole proprietorship.
- C Corporation. These corporation files IRS Form 1120 and pay any tax due as a separate entity. Shareholders, aka owners, also pay tax at their individual income tax rates for dividends or other distributions from the corporation. Yes, the double tax that tax opponents often cite and which discourages some from converting to C corp status. Corporations also can be professional or personal service corporations; this is typically used by professionals like lawyers, doctors and architects.
- S Corporation. This type of corporation has tax treatment similar to a partnership. An S corporation files IRS Form 1120-S, which passes most income or losses to shareholders/owners who are responsible for reporting the information on their individual tax returns.
Other TCJA considerations: While the TCJA did reduce some taxes — permanently for large corporations and through 2025 for small businesses — it did not make complying with the tax code any easier.
In fact, it complicated it in many ways.
Take the 20 percent pass-through deduction. There are caps and phase-out amounts that must be calculated when claiming it.
The caps are $157,500 of total taxable income for a single taxpayer or $315,000 of total taxable income for married filing a joint return.
When your earnings exceed those caps, you can only claim a partial deduction. Arriving at that amount means more calculations, including consideration of depreciable assets.
Note, too, the phrase "total taxable income." This is different from the usual standard of adjusted gross income, which determines certain tax deductions that may not be related to how you calculate qualified business income.
And don't forget to take into account the limitations on the W-2 wages paid by the business.
See what I meant about TCJA not being tax simplification?
4 business tax tips: Finally, a few tips for small businesses when it comes to taxes.
First, hire a reputable, qualified tax professional. The new tax law's revised rates, entities, limitations, definitions, caps, etc. that I lightly touched on above mean that every small business owner now more than ever needs tax help. That means finding a tax pro who specializes in business taxes, and particularly small business taxes. That tax advisor will help make sure that your business takes taking advantage of all the TCJA has to offer. Similarly, he or she will ensure that you and your business are doing so appropriately.
And regardless of the latest tax law and whatever tax law changes Congress will make in the future — and you know they'll be tinkering with the Internal Revenue Code again — small business owners also should:
- Think about taxes year-round. Taxes are not just a once-a-year filing event, especially for businesses, which have a slew of tax obligations. If you approach them that way, you'll find yourself and your company in dire tax straits or at the very least likely over-paying your taxes. There are beau coups tax actions that you cannot do retroactively. So start proactively thinking about your company's taxes now.
- Keep an eye on tax law changes. Your tax pro — you didn't follow that first tip, right — will stay up to date on tax changes. However, it never hurts for a small business owner to follow tax news, too. If you hear of something, run it by your tax pro, who can explain whether what you hear is accurate and if so whether it applies to you and your company.
- Run your company as if taxes don't matter. Yes, I just offered three tips that require your near-constant attention to taxes. Those said, however, taxes are part of your business, not your whole business. Don't make business decisions or changes based solely on taxes. Or, to paraphrase the old saying, don't let the tax tail wag the business dog. Be cognizant of the tax effects, but make decisions that are based on the best overall business moves for your company.
Aren't you glad you started our own company? Sure you are! And so are we.
That's why we salute all small businesses this and every week. And wish all y'all success in both navigating your taxes and turning a profit.
You also might find these items of interest:
- 4 tax tips for new businesses
- Buffett's Berkshire gets $29 billion boost from GOP tax bill
- Family businesses get estate tax break thanks to Treasury decision to revoke tax regulation