How the Trump Tax Plan Affects Your BusinessMarch 25, 2019 April 1, 2019 /
The Trump tax plan has ushered in the biggest changes to US tax law since 1986. Have you noticed how it affects your business?
Officially known as the “Tax Cuts and Jobs Act,” the new tax plan was signed into law by President Trump to take effect from January 1, 2018. This means that we are just seeing the impact of the tax bill as people and companies file their 2018 taxes with the IRS.
As with any updates to tax policy, there are many complexities to learn. For many businesses, the previous tax law was the norm, so the changes represent a learning curve. It’s obviously challenging to talk about every nuance of the tax code, so here we’re breaking down some significant changes for businesses.
Business structure tax reform
One of the first dependencies for your business is how it is structured. Under the Trump tax plan, different types of business entities fare differently in terms of deductions, federal tax, and eligible credits.
For now, let’s look at those who have a C Corp – a corporation that is a separate legal entity from those who own it. One of the big changes under the Tax Cuts and Jobs Act is that the corporate tax rate shifts to a flat rate of 21%. Previously, the tax rate ranged from 15% to 35%, so under the new rules, most will see a tax cut.
In most cases, this tax break is of benefit to larger businesses. The majority of smaller businesses in the US are structured as LLCs, S Corps or Sole Proprietorships.
Alternative Minimum Tax (AMT) repealed
The Alternative Minimum Tax (AMT) was previously imposed under the old tax system at a rate of 20%. Any corporations with annual average gross receipts of less than $7.5 million for the previous three years were exempt.
The AMT was always a fairly complex calculation that needed to be done alongside calculating taxes under the regular corporate tax rate. The two were calculated side by side, then the corporation was required to pay whichever was the higher amount. This was a way to prevent corporations from substantially minimizing their tax contribution through deductions. It guaranteed corporations would pay a certain rate despite any deductions.
The Trump tax plan repeals the AMT. However, your business may be entitled to use any carryover. In earlier years where corporate AMT was paid, the prior law allowed an AMT credit. This new tax law allows corporations to fully use their AMT credit carryovers in their 2018 through to 2021 tax years.You may be entitled to use AMT credit carryovers through to 2021 Click To Tweet
Pass-through tax deduction
The new pass-through deduction is for other types of business entities, other than C Corps. “Pass through” refers to how taxation is treated for entities such as Sole Proprietorships, S Corps and LLCs. Rather than paying income taxes as a separate entity, it is “passed through” to the owner and treated as personal income.
Under previous law, this was not treated any differently by the government – the finances of the business and the owner were intertwined, taxed at standard rates, and there was no extra benefit.
The big change under the new tax plan is that a pass-through deduction may apply. This allows business owners to deduct 20% of Qualified Business Income (QBI) and is in effect at least through to 2025. To many of these types of businesses, this represents a significant tax cut.
It’s important to note that there are restrictions around this new tax deduction. Business owners must have a taxable income of below $157,500 if single or $315,000 if married and filing jointly to qualify. If you do qualify, a 20% deduction will be applied to whichever is lower— the ordinary income of your business, or your taxable income minus any capital gains.
The definition of QBI is also important to note. It is generally defined as income, gain, deduction and loss that are effectively connected with the conduct of a U.S. business. Items that may not be counted as QBI include: reasonable compensation paid to an owner for services rendered to the business, guaranteed payments to a partner or LLC member treated as a partner for services rendered to the partnership or LLC, and certain investment items.
There’s also a W-2 wage limitation set on the pass-through deduction, designed to limit people from declaring themselves a separate business or contractor for wages earned via W-2. For pass-through entities other than sole proprietorships, the QBI deduction generally can’t exceed the greater of the owner’s share of:
- 50% of the amount of W-2 wages paid to employees by the qualified business during the tax year, or
- The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property.
If you are considered a “professional service” (such as lawyers, doctors, and accountants), there are restrictions on the pass-through deduction. If individual income exceeds $157,500 (or $315,000 for joint filers), then restrictions on the deduction are phased in for every $50,000 over ($100,000 filing jointly).
Write-offs for expenses
In a nutshell, there are some bigger write-offs for the big expenses your business incurs, with the exception of any structures. The Trump tax plan allows your business to write off a larger portion of large equipment purchases up-front, rather than amortizing them over several years under previous tax law. Now, you may take 100% of the cost of the equipment as a deduction in year one, instead of the previous 50%.
As another added bonus, while depreciation used to only cover new equipment purchases, under the new tax rules it covers all equipment still in use. Old or used equipment, large or small is included. By writing off the entire cost up-front, you have the option to spread the cost of equipment over several years, until you either recover the cost or cease to use it.
In addition to a larger percentage, you also have the option of spreading the deduction over five years. Previously, you had to take the deduction in the year that the equipment was purchased.
Bonus depreciation is in effect for qualified property that is placed in service from September 28, 2017 to December 31, 2022. After this time, bonus depreciation is scheduled to be reduced as follows:
- 80% for property placed in service in 2023,
- 60% for property placed in service in 2024,
- 40% for property placed in service in 2025, and
- 20% for property placed in service in 2026.
Method of accounting
The Trump tax plan enables more companies to use the cash method of accounting, as opposed to the accrual method that was previously required.
The cash method means that revenue is recorded as soon as it comes in, while expenses are recorded as soon as suppliers and employees are paid. The accrual method is where revenue is recorded when it is earned, but expenses are only recorded when consumed.
What is the advantage for businesses using the cash method? It’s all in the timing of when revenue and expenses are recorded. If you use the accrual method, you have to wait until selling inventory before you deduct the expense of purchasing it, meaning you could potentially wait for a significant period. The cash method means you get to deduct the cost of inventory immediately.
If you are a business that operates with inventory, and especially if you are in a fairly volatile market, it can also be a costly exercise having to figure out the value of your inventory, as you do with the accrual method. The cash method eliminates this because you have already deducted the expense of inventory.
Most manufacturing businesses have been required to use the accrual method if they have annual revenue of $5 million or more. Under the new tax plan, this threshold is raised to $25 million, giving more manufacturing businesses the option of the cash method.
The Trump tax plan brings in some new tax credits that benefit businesses. In an effort to encourage businesses to pay when employees need leave, the new tax law allows deductions for paid medical or family leave.
The tax credit for this leave ranges from 12.5% to 25%, however, this credit only lasts through 2019.
Tax deductions repealed
There are also some deductions that have been repealed:
- The Domestic Production Activity Deduction (DPAD or Section 199 deduction). This had allowed a 9% deduction on income for qualifying manufacturing activities. The idea had been to incentivize domestic production creating jobs for Americans, however it was often criticized as a loophole. For example, companies could claim the deduction even if only a tiny portion of assembly was done domestically, while the bulk of manufacturing was done in a foreign country.
- Entertainment expenses. Paying for client dinners or tickets to events has been a common way for businesses to engage with their clients. Previously, a 50% deduction for these expenses was allowed, however the new tax law eliminates this deduction altogether.
- Employee meals. Providing meals on-site was 100% deductible under previous tax law, now the deduction falls to 50%. The meal deduction disappears completely in 2025.
- Employee transport. If you have previously enjoyed a deduction for providing employee transport or parking, you’ll find this is eliminated under the new tax plan.
- Business interest deduction. This one is not entirely repealed but it is significantly reduced. Where previously most businesses could deduct all of their interest expenses, under the Trump tax plan this is reduced to 30% of adjusted taxable income.
This article has provided a general overview of some of the most pertinent changes for businesses under the Trump tax plan. How it impacts you specifically as you file and pay into the Treasury depends on how your business is set up as well as typical income and expenses.
Tax planning is important, especially with so many changes to tax law. To establish what your company needs to do to maximize changes under the new law, be sure to engage a qualified professional. Taxation can be a very complex issue, but we help to simplify it for your business.