Grading the Tax Cut and Jobs Act: What It Means for Small-Business Owners
The new tax legislation, The Tax Cut and Jobs Act, could be the largest rewrite of the tax code in decades, and with it comes a tremendous amount of debate and scrutiny.
The bill outlines an aggressive $1.51 trillion plan to cut taxes for corporations, reduce taxes for the middle-class, and purports to help businesses and America compete in the world market place.
Yet, is all of this rhetoric about helping small business just smooth talking? I really was looking forward to this tax bill. Talk of helping pass-through businesses, or small businesses, and tax cuts to help build the economy.
The simple reality: it's essentially a simplification of the tax code and a huge tax cut for large corporations. But, the devil is always in the details isn't it. Well, I've read the entire Act and I'm here to give Paul Ryan and the House a report card from us, the small-business owners.
It isn't pretty.
1. Maximum rate on business income of individuals: D-
Under current law, owners of entities such as sole proprietorships, partnerships, LLCs and S corporations pay tax on the pass-through income on their individual tax returns at their marginal rate, which can be as high as 39.6 percent.
Lawmakers decided to tax that pass-through income at the maximum rate of 25 percent, rather than the individual's rate that could be higher. Sounds great right, right? Well here are the details.
- First, the 25 percent rate only applies on 30 percent of the pass-through income, after any salaries to the owner, if applicable. Moreover, it's based on this elaborate "capital percentage" equation and optional formula that certainly isn't simplifying anything.
- Next, if it's considered passive income, meaning the business owner isn't even involved, which I think defeats the purpose of trying to stimulate small business activity, then the 30 percent limit doesn't apply. Who will this actually benefit?
- Then, the 25 percent rate isn't even available to businesses involving the performance of services in the fields of law, accounting, consulting, engineering, financial services or performing arts. I want to know how medical professionals dodged this bullet!
- But, the real catch is, with the individual tax brackets being simplified, all taxpayers making less than $260,000 (married filing joint), have a maximum rate of 25 percent anyway. So again, who are these "small businesses" we are helping when you have to make north of $300,000 before you might even reap a benefit!
In summary, if you are an S corp owner, and making less than $260,000, this whole complicated and elaborate equation won't even help you. Moreover, it will probably increase the scrutiny of S corporations and what constitutes a reasonable salary, thus causing a chilling effect on a great strategy for small-business owners and more problems, rather than help.
Now, we get to Section C and D of the Tax Cut and Jobs Act, interestingly titled "Small Business Reforms." Note that it's referred to as "reforms," not "incentives." There's a reason for that.
2. Expansion of Section 179 expensing: D-
Under current law, businesses may immediately expense up to $500,000 of the cost of any new and qualifying property placed in service each year. The new law expands this to $5 million. That's great, but again, can you please give me a list of small businesses spending $1 million or more on new equipment?
This is another tax benefit targeted to help big business and large corporations, disguised as a tax strategy to help 'small business'. Moreover, its net financial effect in the legislation is less than .007 percent compared to the tax benefit handed to big corporations with the reduction in the corporate tax rate.
3. Small business accounting method reform and simplification: F
This is an extremely complicated part of the bill that focuses on cash-basis accounting, inventory costs and long-term contacts. The bulk of these changes are now expanded to businesses with up to $25 million in sales, which were previously limited to businesses with much lower sales. But, again, I guess I'm missing the point that small businesses are defined as $25 million in sales. I'll remember to remind my clientele -- people like dentists, coffee shop owners, realtors and internet marketers -- of this new development.
4. Reform of business-related exclusions, deductions and more: F
This is where things get fun. In order to pay for the massive reduction in corporate tax rates, this new legislation guts or completely eliminates numerous tax deductions and strategies that historically have helped small businesses. Allow me to just summarize:
- Business interest deduction -- gutted and limited
- Net Operating Loss (NOL) -- gutted and limited
- 1031 Like-Kind Exchanges -- drastically changed and limited
- Local lobbying expenses -- repealed entirely
- Entertainment expense -- repealed entirely
- Domestic Production Income Deduction -- repealed entirely
- Employer-Provided Child Care Credit -- repealed entirely
- Rehabilitation credit for historic buildings -- repealed entirely
- Work Opportunity Tax Credit -- repealed entirely
- New Markets Tax Credit -- repealed entirely
- Expenditures to provide access to disabled individuals -- repealed entirely
- Credit of FICA and tips for restaurant owners -- repealed entirely
The list goes on actually. This 'simplification' of the tax code is a smoke screen for massive tax breaks to large corporations and the repeal of numerous tax strategies and deductions for the small business owner.
Overall grade for the Tax Cuts and Jobs Act: F
There is still a lot to be debated and the final version is far from certain, but if you think big tax breaks for Walmart, Amazon and Microsoft will create jobs and stimulate our economy, then maybe you should jump on board.
However, we as small-business owners should be vocal about our concerns and be extremely wary of this legislation.