Leading up to the December 2017 passage of the Tax Cuts and Jobs Act (TCJA), legislators touted the measure as a win for small business owners. In addition to numerous changes designed to simplify the federal tax code, Republicans in Congress said entrepreneurs were sure to see a larger tax return than previous years.
Many of the changes that affect small businesses went into effect last year. Initial reports suggest that small business owners are indeed seeing larger returns, despite the average taxpayer generally receiving a smaller refund.
Since many entrepreneurs and small business owners have yet to file their taxes, despite the IRS' April 15 deadline looming on the horizon, we looked at some of the ways President Donald Trump and the Republicans' biggest legislative win can affect small businesses.
Major deductions a 'huge win'
When it comes to the TCJA and its 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 for the deduction of 20 percent of qualified income.
A.J. Gross, president at ALG Group, said this change to the tax code has brought about the most significant deduction for small business owners.
"The 20 percent deduction is a game changer," he said. "It is a huge win, in my mind, for small businesses."
In one instance, Gross said the owner of a small insurance company that regularly pulls in $400,000 in annual income received a nearly $60,000 tax bill. While the return amount that a small business can receive because of this deduction varies from case to case, he said most clients have seen an upswing in their returns.
While that's 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 deduction. After numerous iterations and additions to the code, there are some hard and fast limitations on who can claim the deduction. [Interested in online tax software for your business? Check our top picks and reviews.]
Tax savings with a catch
While the deductions are generally a win for small businesses, Dr. Steven J. Weil, the president and tax manager of RMS Accounting in Fort Lauderdale, Florida, 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" (SSTB) that deal "in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services" and other 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 who 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 percent deduction, though they must keep separate bookkeeping records for each building they rent out and they must perform at least 250 hours of rental services in the tax year.
Entertainment deductions removed
Along with the inclusion of the 20 percent deduction, another 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 percent 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 percent. Additionally, promotional events are still deductible, if the company's message is the focus of the event. Gatherings for employees, such as a holiday party, are also still deductible.
Tips for 2020
Since this year's tax season is close to winding down, Gross says it's never too soon to plan for next year.
One consideration small business owners should make moving forward is how much to withhold for federal taxes. This single decision, he said, has a big impact on whether or not a large return is coming next year.
"It's personal preference. 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," he said. "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 percent deduction is for pass-through entities, he said 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," he 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 ensure they get the best tax return are "seek out a professional" and keep a well-organized file for your documents.
"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.]