The Tax Cuts and Jobs Act recently signed into law has implications for personal tax planning and estate planning, but its primary effect is on all sizes of businesses. If you are a business owner (or plan to start a new business) there are some important changes to keep in mind that may affect your business structure and strategies.
20% Deduction for “Pass-Through Businesses”
95% of US businesses use “pass-through” business structures for taxation. These include sole proprietors, partnerships and S-corporations, where the business income is essentially taxed as personal income, at the corresponding personal tax rate.
The new law now provides for a 20% deduction on that income, a change that is bound to benefit some small to medium size business owners by lowering their tax bill. However, there is a caveat where service-based businesses (lawyers, accountants, doctors, etc.) can only claim the deduction if their annual income is less than $315,000 for married couples, or $157,000 for single filers.
The definition of ‘service-based’ business in the new law is far from clear, and some business owners are considering ways to shift or diversify their work activity in order to claim the deduction.
Corporate Tax Rate Lowered From 35% to 21%
The most significant part of the new tax law is the reduction in corporate tax rates from 35% to 21%. Lower corporate taxes could motivate some businesses to convert to a corporate tax structure, especially if they fall within the exception to the 20% business income deduction.
Selecting a Business Structure
Many small businesses choose to use a simple legal and tax structure for their business, to avoid the paperwork and administration of a C corporation. This is probably still the right choice for businesses with a mid-level income, but in some cases the new tax law might make the C corporation election more beneficial.
Naturally, this is a complex decision that requires the advice of both tax and legal professionals to evaluate the effect of tax reform on existing and planned business structures. Here are some of the key factors that you might have to consider in your business planning process:
- The type of business you own (service or capital goods, or some combination).
- The amount of pass-through income (after deductions) for service-type businesses.
- Whether a C corporation structure is suitable for your business, and how it might affect partners, investors or family members.
- What steps are needed to convert your existing business structure, and if the tax savings is worth the effort and expense.
- Accelerating expenses to decrease business income.
- How your business is included in your estate plan, along with the distribution of ownership after death.
- Business succession planning for family businesses.
- How to maximize retirement fund contributions or charitable giving to reduce annual income.
If you are a business owner and have questions about how tax reform might affect your company’s taxable income, now is a good time to consult your attorney and accountant. The tax law is in effect for 2018, and choices that you make now will affect this year’s tax bill.