Now that President Donald Trump has taken office and the Republicans control both chambers of Congress, major tax reform is likely on the way that could meaningfully benefit small businesses across the country.
Steven Mnuchin, Trump’s candidate to run the Treasury Department, has stated that comprehensive tax reform will be an immediate priority of Trump’s administration, and that his focus as Treasury Secretary will be stimulating economic growth and creating jobs through tax reform.
But how will this affect small businesses and their owners?
Breaking down the two reform plans
There are two major comprehensive tax reform plans being discussed currently: President Trump’s plan and the plan put forth by the House Ways and Means Committee, commonly referred to as the “Blueprint.” The two plans are similar in many aspects, but diverge in certain important provisions.
One of the major components of the Trump plan is to cut corporate tax rates from a maximum of 35 percent to 15 percent. The U.S. has one of the highest corporate tax rates in the world, and it is believed by both parties that American businesses could compete more effectively in a global marketplace if they were not hamstrung by these high tax rates. Mnuchin has said, "By cutting corporate taxes, we're going to create huge economic growth and we'll have huge personal income."
However, these tax savings apply only to C corporations, and the majority of small business is conducted as one form or another of pass-through entities -- partnerships, limited liability companies (LLCs) taxed as partnerships or S corporations. Accordingly, one point of contention that hampered the ability to achieve tax reform throughout the Obama Administration was the Republicans’ refusal to agree to a lower corporate tax rate without addressing the issue of pass-through entities.
The Trump plan and the Blueprint seek to address this issue in two key ways. First, both plans call for three tax brackets -- 12, 25 and 33 percent -- although they differ on when each bracket will apply. The current maximum tax rate on individuals is 39.6 percent on taxable income over $250,000, and 43.4 percent if the individual is subject to the Net Investment Income Tax (NIIT). Both reform plans call for the elimination of the NIIT, so the reduction in individual rates alone could save small business owners up to 10.4 percent in their maximum tax rate.
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Implications for small businesses
Greater savings may eventually ensue. According to the Tax Policy Center, Trump’s plan includes the ability for pass-through entities to elect a maximum rate for “business income” of 15 percent. This applies to active trade or business income from pass-through entities, except distributions from “large” pass-through entities would be taxed as dividends.
The Blueprint has a similar concept, but increases the maximum rate to 25 percent. If one of these plans makes it into an overall tax reform package, small business owners could realize a savings of up to 28.4 percent on their K-1 income from the companies they own.
Both plans have provisions that allow full expensing for all capital investment, but in general, a company would have to forgo any deduction for net interest expense. This would effectively provide for an unlimited Section 179 deduction with no phase-outs occurring at any level of investment. Currently, Section 179 allows for $500,000 of expensing, but the deductions start to disappear after $2 million of investments.
Estate tax revisions
Several other proposals may also benefit small business. For example, both plans call for a complete repeal of the Alternative Minimum Tax, which affects many small business owners. Trump’s plan calls for a revision of the estate tax that would make capital gains over $10 million held at death subject to tax, while the Blueprint calls for a total repeal of the estate tax. Either provision, if enacted, would help small business owners pass their companies down to the next generation without the same tax burdens they face today.
While either proposed plan faces obstacles based on the projected costs of the tax cuts, if comprehensive tax reform is enacted in the early part of the Trump administration, it is likely to contain multiple provisions that will benefit small businesses and their owners.