As many of you are aware, the recently passed federal tax legislation, also known as the Tax Cuts and Jobs Act (the Act), has a substantial impact on the tax treatment of small businesses. The National Law Review has provided an in depth resource regarding new tax planning opportunities for owners of small businesses. We’ve reviewed the article, and have provided our best attempt at a clear and short summary.
Under the new tax code, businesses known as “pass through entities” will likely feel the most significant impact, but also may derive the greatest benefit from creative business planning. Pass through entities are businesses such as LLCs, partnerships, and sole proprietorships. They are known as “pass through entities” because the businesses themselves do not have a tax liability, instead, any taxes that the business may owe “pass through” to the individual owners of the business.
The Act treats these businesses differently in several ways. Some of these changes are positive, while others may have a negative immediate impact on taxation.
The Act nixes several owner friendly deductions, including:
· the deduction for interest expenses above certain thresholds;
· the deduction for business entertainment expenses; and
· the individual deduction for state income tax and real estate tax in excess of $10,000.
Not all the news is bad though. While some friendly deductions have been lost, the Act affords the owners of pass-through entities a new deduction:
· up to twenty (20) percent of their qualified business income from their taxable income (with certain caveats and exceptions)
· The deduction aims to incentivize job creation and making business related purchases
Certain industries, by their nature, may not be able to recoup the tax benefits of the new Act when compared to the deductions that were previously allowed under the prior tax plan. For example, high earning service professionals, from doctors to professional athletes will not likely reap the advantages as much as a retail or manufacturing business.
For the business owners out there, depending on the nature of your work, it may be wise to look into reforming your business into something other than a pass through entity. For example, a “C corporation” might be a better fit for you under the new tax plan.
We are happy to sit down with business owners of all shapes and sizes to discuss how some of the changes may affect them, and options for getting organized under the new plan.
*This post was written by Patrick E. McNamara and Pierce D. Fiala as summary of the National Law Review article entitled “New Pass-Through Deduction Presents Tax Planning Opportunities for Pass-Through Owners,” published January 22, 2018.