The Tax Cuts and Jobs Act, which went into effect on January 1, 2018, likely had a profound impact on your business and your business taxes. And if you have questions about the Trump tax breaks for small business, we’re here to help. The IRS’s tax code is complicated as it is. Now, with all of the tax code changes passed into law, how will the tax reform plan affect small businesses?
The updated tax code sets into motion new deductions and credits that affect each small business’s tax liability differently. If you’re still trying to figure out how the Donald Trump tax plan will impact your small businesses this tax season, this breakdown will help.
The Tax Cuts and Jobs Act was legislation passed in December 2017 that gave the U.S. tax code its largest overhaul in over 30 years. Among other things, the legislation nearly doubled the standard deduction, placed new limitations on itemized deductions, reduced the income tax rate, and made reforms to several other key provisions.
Overall, the Tax Cuts and Jobs Act aimed to simplify the tax system. One of the biggest effects of the legislation was to cut the amount of income tax large American companies have to pay. But how did it affect small business? Let’s take a closer look.
The impact the Tax Cuts and Jobs Act has on your business depends on how your business is structured. Some entities will be eligible for new deductions and credits, while others will not. Also keep in mind that while some of these changes have been instituted in perpetuity, while others expire as early as 2019, and others last through 2025.
So let’s first re-establish the different categories of businesses entities at the center of Trump’s tax plan:
Under the Tax Cuts and Jobs Act, C-corps are taxed at a flat rate of 21%—a cut from the previous range of 15%-39.6%.
While this is a high profile component of Trump’s tax plan, most small businesses aren’t structured as C-corps. The majority of U.S. small business are pass-through entities, such as LLCs or S-corps. So this change mostly impacts Fortune 500 companies rather than small businesses.
Small businesses not structured as C-corps might be affected by the pass-through deduction. The main difference that distinguishes a pass-through entity from a C-corp is how taxation is handled (hence, why we’re talking about it). So, rather than paying income taxes as a totally separate entity, the pass-through entity passes the profits and losses through to the owner. The business owner then reports that as personal income. In that way, as the government sees it, the finances of the owner and the business are pretty intertwined.
The absolute biggest thing you need to know is that under the Trump tax plan, small businesses that are filing as pass-throughs can take a 20% business income deduction.
To qualify for this 20% deduction in 2019, business owners must have a taxable income of below $160,700 if single or $321,400 if married and filing jointly. So, if your business is structured as a sole proprietorship, partnership, LLC, or S-corp, you could qualify for this pass-through deduction of 20%.
The deduction doesn’t lower your adjusted gross income, and you aren’t required to itemize on your taxes in order to take it. If you do qualify, a 20% deduction will be applied to whichever is lower—your qualified business income (the ordinary income of the business), or your taxable income minus capital gains.
Unfortunately, there’s a big one here. If your pass-through business generates revenue through the professional services of one individual—think doctors, lawyers, accountants, and consultants, for example—you’re not eligible for the deduction. However, if you are a sole proprietor operating outside the field of professional services (e.g. you sell goods), you’d be eligible to take the deduction.
A provision of Trump’s tax plan lets businesses write off a larger portion of large equipment purchases up front, instead of depreciating them over a number of years.
These changes are part of a tax-saving tool called bonus depreciation. Basically, when your business buys a new piece of equipment, you typically can write it off a little at a time each tax season. This is a new tax deduction that lets you write off the entire cost of that equipment purchase for the year you bought it. This way, you can spread out the cost of an asset you purchase and use for business over a number of years (like a car) until you either recover the cost of the asset or stop using it.
Bonus depreciation used to only cover new equipment purchases—but under Trump’s tax plan, it’ll cover all equipment that’s still in use. Previously, businesses were only able to deduct up to $500,000 in equipment purchases. Under the Trump tax plan, business owners can deduct up to $1 million in equipment purchases.
How do these new equipment deductions from the Donald Trump tax plan affect your small business? Under the new tax plan, you can deduct 100% of the cost of an asset in the year you buy it, whereas previously you were only able to take 50% of the value.
In addition to increasing the percentage of value you can deduct, the new law lets you take the deduction over five years, whereas previously it was only eligible in the year the asset was placed in service. The deduction has also expanded to include used or old equipment—anything as big as a building or as small as a computer. This deduction has also been expanded to include building improvements like a new HVAC system or fire alarms.
So, if you’ve purchased new equipment, a new vehicle, or snapped up any new real estate since September 2017, this element of the Donald Trump tax plan benefits your small business. You can write 100% of the cost for that off this year.
The Alternative Minimum Tax (AMT) is a tax tool designed to make sure that large corporations don’t take too many deductions and avoid paying taxes. The Donald Trump tax plan repealed the corporate AMT, which helps guarantee that businesses can reap the benefits of the new tax cuts.
Essentially, the AMT is a separate way of calculating your tax liability. Every business is required to calculate its tax burden in two ways: the normal way for corporate income taxes and with the AMT. Most tax software will automatically make both of these calculations for you. Once those two calculations are made, the business must pay whichever is the higher of the two tax burdens.
Figuring out the AMT is pretty complex, but the only thing you really need to know is that you don’t have to figure it out anymore at all. There is no longer an AMT to calculate for small businesses. So, if you feel like you’re finding deductions and exemptions that make your business’s tax burden easier, ride the wave—there’s no alternative calculation to hold you back!
The Donald Trump tax plan lets more companies take advantage of the cash method of accounting, rather than the accrual method. Using the cash method of accounting, revenue is recorded as soon as the cash is received from customers, and expenses are recorded as soon as they’re paid to suppliers and employees. That’s different from the accrual method, in which revenue is recorded when it’s earned and expenses are only recorded when consumed.
The time difference is the important part. Under the accrual method, business owners could get stuck waiting until they sell inventory to deduct the cost of it, rather than being able to deduct it when they make the purchase.
Generally, manufacturing businesses are required to use the accrual method, but the new tax plan raises the annual revenue threshold from $5 million to $25 million, drastically increasing the number of businesses that can qualify for an exemption from that rule.
That’s a huge benefit for any manufacturing businesses and for any small businesses that deal with inventory. And here’s why: Accrual accounting requires that income and expenses be booked when they are owed, rather than when they are paid or received. It can be costly to figure out the value of inventory—especially for small businesses who operate in volatile markets where pricing is always fluctuating.
The takeaway here? Many more small businesses will now be able to deduct inventory when they pay for it, rather than needing to wait until that inventory is sold.
The Donald Trump tax plan also created a credit for wages paid for family or medical leave. The intention of this tax credit is to encourage employers to pay when their employees need leave—a fringe benefit that can be tough on small businesses. Depending on the amount of wages paid out, the tax credit can range from 12.5% to 25%.
To get the tax credit, you must have a written family leave paid time off policy and grant your employees at least two weeks of PTO. Note that this tax credit expires after 2019.
Although Trump’s tax plan brings several new credits and increased deductions, the Tax Cuts and Jobs Act also removes some benefits and tax tools that small business owners used to take advantage of across all sectors.
With that in mind, it’s important to remember that each industry will be affected by changes to the Trump tax code differently. Some of these tax changes could impact your small business by increasing your tax burden. Here is a list of all the changes that could negatively impact your business.
The business interest deduction was an important part of the prior tax code that helped out business owners who took out small business loans to cover relevant operating costs. The interest on those business loans would be deductible as an ordinary business expense.
Under the Donald Trump Tax plan, the business interest deduction is cut to 30%. That’s a long way from before, when the business interest deduction wasn’t restricted at all. This impacts the way small businesses file taxes because they can now only deduct an interest expense of up to 30% of their business’s EBITDA (earnings before interest, taxes, depreciation, and amortization).
While this mostly impacts companies with a taxable profit, like C-corps, small businesses that have a lot of debt on their books should be especially conscious of this change. But it’s not all bad news: If your small business has an annual average gross receipt of $25 million or less for the past three years, your business is exempt from this rule.
Trump’s new tax plan got rid of a deduction that was commonly claimed by manufacturing businesses, called the Section 199 deduction.
Section 199 allowed business owners to take a 3% deduction on income from qualified production activities, with the intention of incentivizing domestic manufacturing in the U.S. This was one of the biggest loopholes cited by critics of the former tax code, as manufacturers were taking advantage of the system.
New they can no longer claim this benefit because it was repealed.
Prior to the Tax Cuts and Job Act, business owners could deduct up to 50% of expenses they’d paid for business-related entertainment. No more: The new tax plan does away with deductions for entertainment expenses—with some exceptions. Buying food for a client at an event can still be deductible (the cost of the food, not the event).
Unfortunately, that means a lot of business owners are going to have to start paying taxes on things like box seats and dinners out with clients. Or drop them from their business plans entirely.
Another employee perk that used to be deductible were employee meals. Now, if you feed your staff on business premises, that food that was formerly 100% deductible under the former tax law is now only 50% deductible. By 2025, it won’t be deductible at all.
This one is pretty straightforward—and one that a lot of small business owners are going to miss. Under the Donald Trump tax plan, business owners can no longer deduct the cost of providing employee parking, public transportation passes, and bike commute reimbursements.
Overall, you can expect the impact of Trump’s tax plan on your small business to be a mixed bag. That’s especially true for an overhaul like this, which completely rewrites many aspects of the tax code. You’ll probably end up finding that some things that may benefit your small business directly, especially if you’re a pass-through entity, and that other pieces, like deductions you’re used to taking, have disappeared.
The most important thing to do to stay informed about how Trump’s tax plan will impact your business is to speak to your accountant or bookkeeper. Keeping open those lines of communication with your tax team will help you find out which new credits and deductions you can take advantage of this year, and in the years to come.