How the new tax law affects small business owners

Updated Jan. 1, 2019  The Tax Cuts and Jobs Act (H.R. 1, "TCJA") is now law. The law contains many provisions affecting both individuals and small businesses. The main provisions affecting businesses are summarized below. Except where otherwise noted, these changes apply to after January 1, 2018.

What's the new corporate tax rate?

The cornerstone of the TCJA is a new lower rate for regular C corporations. C corporations are separate taxpaying entities with their own tax rates. All C corporations are subject to a single flat tax rate of 21 percent.

New pass-through tax deduction

The vast majority of smaller businesses aren't organized as C corporations. Instead, they are "pass-through entities." This includes sole proprietorships, limited liability companies, partnerships, and S corporations.  These entities pay no taxes themselves. Instead, the profits from businesses are passed through and the owners pay tax on them at their individual tax rates. These rates can now be higher than the 21 percent rate for C corporations-under the new tax law.  The TCJA creates a brand new tax deduction for individuals who earn income through pass-through entities. Such individuals may be eligible to deduct an amount up to 20 percent of their net business income. This is in addition to all their other business deductions, like mileage or a home office deduction.  If this deduction applies, a passthrough owner is effectively taxed on only 80 percent of business income. Thus, the effective rate for passthrough owners in the top 37 percent tax bracket is 29.5 percent.  This is a personal deduction passthrough owners can take on their returns whether or not they itemize. This deduction is scheduled to end on Jan. 1, 2026.

How does the pass-through tax deduction work?

This complex deduction works as follows:

Income below $315,000 ($157,500 for Singles):

A passthrough owner qualifies for an income tax deduction equal to 20 percent of net passthrough income if he or she:

 
• Operates the business as a sole proprietor, LLC owner, partner in a partnership, or S corporation shareholder and
 
• Total taxable income for the year from all sources after deductions is below $315,000 if married filing jointly, or $157,500 if single

This deduction is phased out if income exceeds the $315,000/$157,500 limits. It disappears entirely for marrieds filing jointly whose income exceeds $415,000 and for singles whose income exceeds $207,500.  You can read more about the pass-through deduction here.

What about service-oriented small business owners?

Special rules apply to pass-through owners whose business involves providing various services. Some of these include:

 
• Health
 
• Law
 
• Accounting
 
• Actuarial science
 
• Performing arts
 
• Consulting
 
• Athletics
 
• Financial services
 
• Brokerage services
 
• Investing
 
• Investment management
 
• Trading and dealing in securities or commodities
 
• Any business where the principal asset is the reputation or skill of one or more of its owners
 
• Engineers and architects are not included

You can still take the 20 percent deduction if your small business is one of these service fields. But, you can only take it if your taxable income from all sources after deductions is:

 
• Less than $315,000 if married filing jointly
 
• $157,500 if single

The deduction is phased out if income exceeds the $315,000/$157,500 limits.  It disappears entirely for marrieds filing jointly whose income exceeds $415,000 and for singles whose income exceeds $207,500.  Service pass-through owners whose income exceeds the thresholds are not entitled to the 50 percent of W2 employee or 25 percent of W2 employee plus 2.5 percent of business property deduction.

What about bonus depreciation?

Bonus depreciation allows you to deduct a substantial amount of a long-term asset's cost in the single year instead of depreciating it over multiple years. The new tax law increases the bonus depreciation amount to 100 percent.  The increase goes into effect for long-term assets placed in service after September 27, 2017. Bonus depreciation may be used for purchases of used as well as new business property.  The 100 percent amount is scheduled to remain in effect until Jan. 1, 2023. In later years, the first-year bonus depreciation deduction amount goes down, as follows:

 
• 80 percent for property placed in service during 2023
 
• 60 percent for property placed in service during 2024
 
• 40 percent for property placed in service during 2025
 
• 20 percent for property placed in service during 2026, and
 
• 0 percent for property placed in service after 2016

You must use listed property over 50 percent of the time for business to qualify for bonus depreciation. Computers can now be fully depreciated under the new tax law.

Automobile depreciation limits

The new tax law increases the annual limits on how much you can depreciate a passenger vehicle used for business:

 
• $10,000 for the first year the vehicle is placed in service
 
• $16,000 for the second year
 
• $9,600 for the third year
 
• $5,760 for the fourth and later years

Bonus depreciation for automobiles placed in 2018 remains at $8,000. The total allowable 2018 depreciation for an automobile is $18,000, by far the most it has ever been.  You can only take this deduction using the actual expense method.

The $1 million Section 179 expensing

The new tax law increased the Section 179 deduction limit to $1 million. This applies to business equipment, as well as vehicles that weigh over 6,000 pounds. You must use the equipment for business over 50 percent of the time to qualify for the deduction.

Limits on deducting net operating losses

A business has a net operating loss (NOL) if its expenses exceed its income for the year. Under prior law, if a business had an NOL, it could be carried back two years.  The new tax law eliminates carrybacks of NOLs. You can still carry NOLs forward and deduct them in current and future years.  Additionally, taxpayers are allowed to deduct NOLs only up to 80 percent of taxable income. Unused NOL amounts may be carried forward and deducted in any number of future years.

Elimination of certain deductions and credits

The new law also eliminates various business tax deductions and credits, including the:

 
• Deduction for business entertainment expenses, except for meals
 
• Deduction for payment of employee parking, mass transit, or commuting expenses
 
• Domestic production activities deduction, and
 
• Deduction for local lobbying expenses