Congress passed tax reform during the week before Christmas of 2017. This was the most sweeping tax law change since the recodification of the tax code in 1986. While it will take some time to determine the finer points of this tax reform plan, we have the nuts and bolts in place to determine what the impact will be for most of our clients.
The impact that the reform will have on businesses is tremendous. The law is full of benefits and incentives for businesses of all types. The law includes a reduction in tax rates and acceleration of deductions. The following changes impact pass through entities that pass their income to their owners to be taxed at their income tax rate. These entities include S Corporations and Partnerships. These entities typically don't include Sole Proprietors, but for the sake of this tax reform act, they are included. The changes impacting pass through entities are listed below:
-Passthrough Income Deduction-The law limits this deduction by business type and income level. Service Businesses-If your business offers accounting services, law services, health care services, financial services, or other services dependent on your skill as a service, you will receive a modified deduction. First, you must have paid W-2 wages to yourself and employees. Second, your taxable income must be below $415,000 for married taxpayers or $207,500 for all other taxpayers. Nonservice Businesses-Income from pass through businesses that do not provide professional services or derive their income from their owners' skill are not subject to the same income limitations. According to our understanding of the law, these taxpayers will receive a deduction as long as their businesses pay
W-2 wages to employees and themselves, regardless of taxable income.
-Tax Rates-The income of pass through entities is taxed to the owner. Individual tax rates were decreased across the board. See our article on tax rate comparisons before and after passage of the law.
-Depreciation-The law increased the amount of depreciation on fixed assets a taxpayer may elect to deduct in the current year through several different mechanisms. The 179 expense election and bonus depreciation were both increased. While this is a benefit, it should be noted that this accelerates a businesses deduction instead of forcing the taxpayer to expense a purchase over the course of several years. This is strictly a timing issue. It is designed to encourage and/or reward investment in businesses by business owners with accelerated deductions.
-Accounting Methods-The law expanded the availability of the cash basis accounting method to larger businesses. It also reduced the requirements for capitalizing inventory. While this is a benefit, it should be noted that no new deductions were written into law. The deductions are now easier to write off more quickly. Also, this change also makes record keeping somewhat easier.
-Meals & Entertainment-Under the old law, taxpayers could deduct 50% of their meals & entertainment expenses that had a business purpose. Under the new law, meals still qualify for a deduction, but entertainment does not qualify. Those expenses have to be added back in full.