- The Tax Cuts and Jobs Act was introduced in 2017. It lowered small business tax rates, especially for C corporations, for which the tax rate decreased by 14%.
- Despite these tax rate decreases, many taxpayers have paid more taxes due to the TCJA because it modified two key small business deductions.
- You can use online tax software to ensure the TCJA’s rules make it into your tax calculations – or hire an accountant.
- This article is for small business owners who want to know how the most recent changes to the federal tax code affect their tax liabilities.
The Tax Cuts and Jobs Act (TCJA) made major headlines in 2017, but that’s all some people know about it. That might be somewhat expected, as taxes are notoriously difficult to understand, which is one reason why many small businesses hire experts to handle their accounting.
However, you should learn the basics of the TCJA because its changes to the federal tax code may profoundly impact your business. Here’s what you should know.
What is the Tax Cuts and Jobs Act?
The TCJA is a federal tax code signed into law in December 2017. The code lowered the top corporate income tax rate from 35% to 21%, though this rate only applies to C corporations. Other changes that the TCJA introduced affect S corporations as well as partnerships and sole proprietorships. These changes lowered the effective maximum tax rate for certain taxpayers from 37% to 29.6%.
These numbers would suggest that the TCJA benefits your business. After all, lower tax rates would theoretically let you keep more of your revenue, thus increasing your profitability. [Related article: Gross vs. Net Revenue]
However, due to other changes it brought, the TCJA often does more harm than good for small businesses.
The TCJA allows individual filers with an income under $157,000 to deduct 20% of their qualified business income. The result is that the effective 37% maximum income rate becomes 80% of its original value, or 29.6%.
What does the TCJA mean for small businesses?
The TCJA could affect your business in several ways. And if these changes feel surprising and concerning, know that you’re not alone – at least according to a Janus Henderson Investors survey released shortly after Tax Day 2019. (The 2018 tax year was the first to be affected by the TCJA.)
- Lower tax payments – sometimes: If your business is a C corporation, the TCJA means that you owe 14% less in taxes per year. If your business is an S corporation, partnership or sole proprietorship, it could also owe less in taxes per year. However, as the Janus Henderson Investors survey found, the deductions that the TCJA eliminates have often resulted in higher tax payments.
- Smaller business interest deductions: Prior to the TCJA, you could fully deduct the interest you paid or accrued on certain business debts. The TCJA has capped this deduction at 30% of your company’s paid or accrued interest. Your maximum deduction would be the sum of your business interest income and 30% of your adjusted taxable income. If applicable, you’d also add floor plan financing interest to determine your maximum. This smaller maximum deduction can increase your tax liability.
- Smaller net operating loss deductions: Before the TCJA, your entire net operating loss for a tax year was fully deductible. You could carry your unused losses back for two years or forward for 20 years. The TCJA now limits this deduction to at most 80% of your net operating loss. You also cannot carry your unused losses back for any amount of time. However, there’s now no limit on how long you can carry them forward. Still, the overall effect can be a smaller deduction, meaning higher taxes.
To reduce your business’s tax liability, make sure you’re aware of all your legal deductions, and reinvest earned money back into your business, specifically your employees.
TCJA: Taxpayer expectations vs. reality
The Janus Henderson Investors survey suggested that most taxpayers were unprepared for the TCJA. The data also indicated that tax professionals didn’t clearly inform their clients of the changes before the filing deadline.
The survey polled 1,002 U.S. adults on how they viewed the TCJA and its effect on their 2018 tax returns.
Matthew Sommer, director of Janus Henderson’s Defined Contribution and Wealth Advisor Services Team, said that the survey showed “mixed feedback” about the TCJA from the firm’s advisors and clients.
“The data confirmed what we had been hearing in qualitative feedback, which is that higher-income taxpayers ended up paying more in taxes than they expected,” Sommer said. “In addition, filers were uninformed about the tax changes, which we believe presents an opportunity for financial advisors to be more proactive in helping clients understand the new tax law and individual implications.”
While many taxpayers had high hopes for the TCJA, some aspects disappointed them.
1. The TCJA brought smaller tax refunds.
As more taxpayers received their 2018 tax refunds, one narrative remained consistent for most: The average taxpayer received a much smaller tax refund than in previous years.
According to the Janus Henderson survey, it was primarily respondents in higher-income households who were disappointed. Among the 254 respondents who reported a yearly household income above $100,000, 42% said they paid more in taxes, even though just 36% expected to have a higher tax liability.
Similarly, 19% reported paying less in taxes, compared with the 28% who thought their tax liability would have been lower. (These figures pertain to small businesses since S corporation, partnership and sole proprietorship income are added to personal income for taxation.)
Officials said that the discrepancy between how much these respondents expected to pay and how much they actually paid likely stems from the TCJA’s $10,000 limit on state and local tax deductions.
“While all taxpayers benefit from five of the seven marginal rates being reduced, higher-income households with substantial property and state income tax liabilities may find that the lower rates are not enough to offset the new restrictions applied to their itemized deductions,” officials wrote.
While higher-income homeowners showed a disconnect between their tax expectations and reality, the firm’s survey showed that most respondents’ tax liability was “on par with their expectations.” When asked to think about how much they paid in taxes over the year, along with any outstanding liabilities or refunds, officials said that 32% expected to see an increase from 2017, even though 30% saw a larger bill.
2. The TCJA caused taxpayer confusion.
Even though the legislation was signed into law by then-President Donald Trump in December 2017, the survey found that most consumers said they were uninformed about the TCJA’s impact on their taxes as Tax Day 2019 approached.
Respondents were asked to rank their comprehension of the legislation’s importance on a scale of 1 to 5, with 1 denoting “not familiar at all” and 5 suggesting they were “very familiar” with the legislation. Officials said the mean score from respondents was 2.05.
Additionally, respondents were asked how much they would be able to deduct if their property tax was $4,000 and their state tax was $8,000. Just 10% of respondents gave the correct answer of $10,000.
Officials said a significant contributor to this lack of understanding was a need for financial professionals to be more proactive in informing clients how the TCJA directly affects them.
Respondents with higher household incomes were more likely to utilize outside professional help. Even so, respondents in households that had hired a CPA or financial advisor said that they weren’t given information to take better advantage of the legislation.
How did the TCJA affect tax debts and refunds?
When it came to paying back debts with the IRS, the survey showed that more than half of higher-income households (56%) said that they would withdraw money from a checking or savings account to cover the difference. Of the households with incomes under $100,000 that received a tax refund, 38% said they planned to save the money, while 23% said they were planning to spend it.
The survey also examined how people used their refunds. It found that 22% of respondents said that they would use their refunds to reduce debt. The other top priority was establishing an emergency fund (15%). Officials said that those were also the top priorities for higher-income households.
If your business undergoes a tax audit, you should hire a certified public accountant or tax attorney to represent you.
How to stay compliant with the TCJA
Given the many changes the TCJA brought, you may feel uneasy when tax time approaches. Fortunately, online tax software platforms are regularly updated to reflect the latest tax codes, including the TCJA.
We recommend starting with TurboTax, which was our pick as the best overall tax software for small businesses. Learn more in our full TurboTax review.
Alternatively, you can hire a small business accountant to file your taxes. This tax professional will calculate your taxes and use their small business tax expertise to help you reduce your future tax liabilities. Plus, they’re an actual person you can contact during regular business hours for expert tax advice, whether you hire them in-house or use a third-party firm.
Even with an increasingly complicated federal tax code, you’ll likely find a solution to your woes if you don’t go it alone.
Andrew Martins contributed to the writing and reporting in this article.