- The Trump Tax Cuts and Jobs Act (TCJA) allows for a 20% deduction of qualified income for qualified pass-through entity business owners.
- There are strict and complex rules surrounding who qualifies for the new tax deduction.
- The TCJA eliminated many entertainment expense deductions.
- Although the tax reform has positively impacted most small businesses, some businesses saw a negative change or none at all.
The Trump administration's Tax Cuts and Jobs Act (TCJA) passed the legislature in December 2017 and went into effect in 2018. This act was designed to simplify the federal tax code and grant entrepreneurs larger tax returns than in previous years by cutting individual income tax rates and doubling the standard deduction.
Although the passage of this act was seen as a win for small business owners, we are finally seeing its effects. Initial reports suggest that small business owners are indeed seeing larger returns, despite the average taxpayer generally receiving a smaller refund since less money was withheld from their pay.
We looked at some of the ways the new tax law has impacted small business owners and how you can prepare for your business's tax return in 2020.
Is the Tax Cuts and Jobs Act a good thing for small businesses?
As with most questions in business, it depends. The impact of the new tax policy depends on your business type and trade. Jake Riniker, CPA and director of business development at Johnson Block and Company, said that some businesses will not see a material change (or it may even increase their tax liability), but overall, there are more advantages and opportunities for tax savings.
Of the TCJA's small business measures, the one that arguably has the biggest impact for most entities is the introduction of a new major tax deduction. Available for qualified business owners at the head of pass-through organizations such as sole proprietorships, S corporations and partnerships, the tax break allows the deduction of 20% of qualified income.
A.J. Gross, president of ALG Tax Solutions, said this change to the tax code has brought about the most significant deduction for small business owners.
"The 20% deduction is a game-changer," he told Business News Daily. "It is a huge win, in my mind, for small businesses."
While this is great news for many small businesses, there are some major caveats. Since the bill's passage, legislators have worked to better define which companies qualify for the new tax breaks and deductions. After numerous iterations and additions to the code, there are some hard and fast limitations on who can claim the new 20% tax deduction. [Interested in online tax software for your business? Check our top picks and reviews.]
Another benefit that many small businesses see is an increase in depreciation opportunities, according to Riniker.
"For small businesses that are purchasing new vehicles or equipment, the TCJA has been beneficial to increase their write-off ability," he said. "The byproduct of increasing depreciation deductions will result in more purchases and increased revenue opportunities for those that sell vehicles, machinery and equipment."
Who really benefited from the TCJA?
According to Steven J. Weil, president and tax manager of RMS Accounting, the TCJA tax reform has benefited many organizations, but not everyone. While the deductions are generally a win for small businesses, Weil said, the changes made an already labyrinthine tax code more complicated.
"The rules are complex," he said. "Those earning too much in certain specified service trades or businesses will lose all of the deductions, while others, who are not in specified service trades or businesses, still may lose part of it if their business does not have sufficient payroll and/or assets."
According to the IRS, small business owners who file as single individuals can only take the deduction if their taxable income is less than $157,500. Those who are married and file jointly must have income less than $315,000. These limits are in place regardless of which industry the business operates under.
Specified service trades or businesses (SSTBs) that deal "in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services" and similar fields are unable to take the deduction if their income as a single filer exceeds $207,500, or $415,000 as a married filer. Instead, those business owners are eligible for a smaller deduction if their income is above the regular $157,500 and $315,000 thresholds but under the SSTB limitations.
Companies that don't fall under the SSTB banner, with an income over the SSTB thresholds, will have a deduction that's capped at a percentage of its employees' W-2 earnings.
Certain landlords are also eligible for the 20% deduction, though they must keep separate records for each building they rent out and perform at least 250 hours of rental services in the tax year.
Although many small business owners benefited from the passage of the TCJA, the primary winners were C-corps. Riniker said that most of the tax savings went to large corporations.
"The corporate tax rate reduced from 39.6% to 21%, which is a significant amount," he said. "Although there are increase opportunities for small pass-through entities, corporate America had larger reductions in taxes."
What deductions were removed?
Along with the inclusion of the 20% deduction, a big change that small businesses should be aware of is the elimination of a large portion of the entertainment expense deduction.
Up until the TCJA's passage, businesses of all sizes could deduct entertainment expenses they accrued while wining and dining clients. Under the previous tax code, up to 50% of entertainment expenses were deductible and allowed tickets to concerts and sporting events, trips, and other big-ticket items to be deducted.
Taking clients out for business-related meals is still deductible at 50%. So are promotional events, as long as the company's message is the focus of the event. Gatherings for employees, such as holiday parties, are also still deductible.
Will tax laws change for 2020?
Although no major tax law changes are planned for 2020, there are several ways for small business owners to prepare for the tax years to come. One consideration small business owners should make moving forward is how much to withhold for federal taxes. This single decision, Gross said, has a big impact on whether a large tax return is coming next year.
"It's personal preference," he said. "Some people like the big refunds because they use it almost like a savings plan, so every year they may want to get that $3,000, $4,000 or $5,000 refund – they just feel like they're getting free money. Other clients just don't want the government to hold their money, so they'd rather have the funds throughout the year and withhold less."
Due to the TCJA's guidelines, Gross also suggests that companies consider how they're structured. Since the 20% deduction is for pass-through entities, ALG has begun telling clients to reconsider becoming an S-corp or similar designation.
"The tax benefit of being an S-corp can be eaten up by extra tax preparation fees and payroll fees," Gross said. "Now, it's just as good to be a single-member LLC and not become an S corporation."
Looking to next year, Gross said two of the biggest steps a small business can take to get the best tax return are to "seek out a professional" and keep a well-organized file of its documents, with itemized deductions.
"The main bottleneck between getting a really solid tax return prepared for a client is how good the documentation is organized," Gross said. "If a client has messy documentation, it's very difficult to do a high-quality tax return ... we always advocate our clients spend some time every month to make sure their documents are in order." [Looking for document management software for your business? Check our reviews and best picks.]
Additional reporting by Andrew Martins. Some source interviews were conducted for a previous version of this article.