Find out the real-world implications of this year's change.
You have likely heard that there was a big change to the United States tax code starting in 2018. As with any change, there are good parts and bad parts, and which is which depends on your point of view. Though it's highly touted as a boon for small business, the overall benefit of the tax reform is in the eye of the beholder. Here are five of the major items that you need to know.
1. Lower tax rates
Who doesn't like lower tax rates? The tax rate for small business pass-through entities (such as S-corporations, limited liability companies, partnerships and sole proprietorships) used to be the same as your individual tax rate. With the change in tax law, that income is now subject to a 20 percent deduction instead. As with most tax law provisions, there are exceptions to taxable income levels: $157,500 for individual filers and $315,000 for those who file jointly.
Anyone under those income levels can take that deduction, but service providers beware.
"Once taxable income exceeds those thresholds, the law places limits on who can take the break," said Jeffrey Levine, CPA and director of financial planning for BluePrint Wealth Alliance. "For instance, entrepreneurs with service businesses – including doctors, lawyers and financial advisors – may not be able to take advantage of the deduction if their income is too high."
2. Entertainment expense
Starting in 2018, entertainment expense is gone. This is across the board, affecting sole proprietors, LLCs, S-corps and C-corps. While many small business owners weren't buying skyboxes or funding weekend golf trips, even the little things are no longer exempt.
The new law no longer allows any kind of deduction for the following:
- Membership dues to a club for recreation or social purposes
- Any activity considered amusement, entertainment or recreation
- Use of a facility for any of the above purposes
This even extends to meals. Most meals were deducted in relation to IRC Section 274(a), related to entertainment expense.
Author, CPA and attorney Mark Kohler says that this will have a profound effect on businesses of every level and the entertainment industry.
"You can't tell me that sporting events, season passes to the theater or golf courses won't feel the impact. Business is a huge part of entertainment and vise-versa [sic]," he said in a recent blog post.
3. Higher bonus depreciation
This has always been a tricky one. What you could take as an upfront depreciation on real estate or equipment has changed on almost a yearly basis, with a percentage upfront and then the rest applied over the next few years. Tax reform has simplified this, with 50 percent upfront in 2017 and 100 percent every year after, starting in 2018. It phases out completely over the next five years – and it also applies to used equipment, not just new, as long as it meets other requirements listed in the provision.
4. Impact on benefits for employees
Every business owner wants to do what they can to make their employees feel appreciated. Tax law used to support that, but not as much anymore. If you provided transportation fringe benefits for your staff, such as parking privileges or public transit passes, they are no longer 100 percent deductible. The transportation benefit has been repealed completely. If you have onsite eating facilities for your employees, the deduction has changed from 100 percent to 50 percent. It is still tax-free for your employees to use.
5. Net operating losses
A net operating loss is when your deductions for the year are greater than your income for the year. This is called an NOL year, and small businesses used to be able to deduct it from their income on another year. It exists to provide some tax relief for small companies. Generally speaking, it means when you make money, you pay taxes, and if you didn't make any money, then you can get some tax relief.
"While companies themselves can't get a tax break if they're pass-through entities (like sole proprietorships, partnerships and S-corporations), their owners can apply their net operating losses on their personal income tax returns," said Jennifer Stinnett with SmartAsset.
Under the old law, you could carry them back to two years or forward for the next 20 years. With tax reform, businesses can no longer use them retroactively for two years, but the 20-year limit has been waived, and you can deduct up to 80 percent of the applicable taxable income.