The Tax Cuts and Jobs Act (TCJA), a $1.5 trillion tax cut package, has several implications for businesses. It was signed into law in December of 2017 and most of its provisions became effective in the 2018 tax year. Below are five ways the new tax codes will impact businesses.
1. Corporate Tax Rates
The new legislation establishes a single flat corporate rate of 21% and abolishes the previous graduated tax brackets of 15%, 25%, 34% and 35%. TCJA permanently repeals the corporate alternative minimum tax (AMT).
2. Pass-Through Business Income Deduction
If you are a sole proprietor or partner who receives business income from a pass-through entity, you typically report that business income on your individual income tax return and pay tax at an individual rate. For tax years 2018 through 2025, a new deduction is available, equal to 20% of qualified business income. This deduction applies to partnerships, S corporations, sole proprietorships and limited liability companies (LLCs) that are not taxed as C corporations. (For related reading, see: Starting a Small Business: Business Structures.)
If taxable income on your personal tax return exceeds certain thresholds, your deduction may be limited or phased out entirely. If you're single with taxable income below $157,500 (or $315,000 if married filing jointly), the 20% pass-through deduction amount can be claimed in full. Single filers with taxable incomes between $157,500 and $207,500 (or between $315,000 and $415,000 if married filing jointly) may be able to claim a partial deduction.
If you are above those taxable income thresholds, the deduction is generally limited to the greater of: 50% of the W-2 wages reported by the business or 25% of W-2 wages plus 2.5% of the value of qualifying depreciable property held and used by the business to produce income. This especially benefits real estate owners and other capital-intensive businesses. The deduction is completely disallowed for businesses that involve the performance of services. This disallowance pertains to industries such as: health, law, accounting, actuarial science, performing arts, consulting, athletics and financial services.
Taxable income doesn't simply mean income from the business. For example, if you are single and your pass-through business income as a consultant is $140,000, and your investment and other income totals $35,000, your combined income is $175,000. You take the standard deduction of $12,000 but have no other deductions. You're above the $157,500 threshold at $163,000 ($175,000 minus $12,000). Since you are employed in the disallowed field of consulting, you won't get any pass-through business deduction.
Here's a different example. Your tax status is married filing jointly. You and your spouse together have taxable income of $300,000. Even if you are a service-based business, you can take the full pass-through business deduction of 20% because you're below the $315,000 income threshold.
3. Bonus Depreciation
The cost of tangible property used in a trade or business usually must be recovered through annual depreciation deductions. For most qualified property acquired and placed in service before 2020, special rules allowed an up-front additional "bonus" amount to be deducted. For property placed in service in 2017, the additional first-year depreciation amount was 50% of the adjusted basis of the property. The TCJA extends and expands first-year additional (bonus) depreciation rules. Bonus depreciation is extended to cover qualified property placed in service before January 1, 2027. (For more, see: An Overview of Itemized Deductions.)
For qualified property that's both acquired and placed in service after September 27, 2017, 100% of the adjusted basis of the property can be deducted in the year the property is first placed in service. The first-year 100% bonus depreciation percentage amount is reduced by 20% each year starting in 2023 (i.e., the first-year bonus percentage amount will be 80% in 2023, 60% in 2024, and so on) until bonus depreciation is eliminated entirely in 2027. For qualified property acquired before September 27, 2017, prior bonus depreciation limits apply (i.e. 50% limit).
4. Expensing
Small businesses may elect under Internal Revenue Cose Section 179 to expense the cost of qualified property rather than depreciating it. The Act increases the maximum amount that can be expensed in 2018 from $520,000 to $1 million and expands the range of property eligible for expensing. The threshold at which the maximum deduction begins to phase out has also increased from $2.07 million to $2.5 million.
5. Foreign Income
Under prior corporate tax rules, U.S. companies were taxed on worldwide profits and received a credit for foreign taxes paid. If a U.S. corporation earned profit through a foreign subsidiary, no U.S. tax was typically due until the earnings were returned to the United States (generally in the form of dividends).
Accordingly, some domestic corporations moved production overseas and multinational companies often kept profits outside the U.S. The new law fundamentally changes the way multinational companies are taxed, shifting from worldwide taxation of income to a more territorial approach. Under the new rules, corporations must pay U.S. tax on prior-year foreign earnings that have accumulated outside the United States in foreign subsidiaries through a one-time "deemed repatriation" of the accumulated foreign earnings.
The one-time tax is not limited to C corporations. It can apply to all U.S. shareholders, including individuals. After paying the one-time deemed repatriation tax, foreign earnings can be brought back to the United States without paying any additional tax. This encourages 10% shareholders of foreign corporations to bring production back to the U.S. and stimulate our domestic economy. The key provision impacting most small business owners is the 20% pass-through business income deduction. (For more from this author, see: 6 Tax Season Tips for Small Business Entrepreneurs.)
The Bottom Line
The Tax Cuts and Jobs Act will impact businesses in a number of ways. Among the most significants changes is the lowering of the corporate tax rate and how pass-through business income will be taxed.
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