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How Tax Reform Will Impact Small Business Owners


Tax reform, it dominated the news over the holidays and while 2018 is here few if any, small business owners know what this legislation will mean for them and their businesses.  Sure, the tax rate is supposed to fall from 35 percent to 20 percent and this sounds like a windfall for most business owners.  However, what happens to the standard deductions that small businesses rely on?  As such, here is an overview of how tax reform will impact small business owners.


Personal Service Corporations


If you are like most small businesses owners then your company is either registered as an LLC or an S-Corporation.  Both are what is known as ‘pass-through’ businesses.  These are businesses which directly pass their profits for the year to the owners of the company – as opposed to corporations which pay the owners through dividends


But the reality of the pass-through tax cut is that the impact will depend on the type of business and the salary the owners pay themselves.  For example, the owners of personal service businesses such as realtors, attorneys, brokers, and even architect and engineers like can only take advantage of the certain deductions if they are married, regardless of whether they are filing jointly or not.


In addition, if the owner were to take a salary from their pass-through corporation, then they will not be able to claim that amount for a deduction.  This can make tax time a bit messy for the owners of pass-through entities and as such, they need to have a discussion with their accountants as soon as possible to make sure expenses for 2018 are properly structured.


Ultimately, the impact of tax reform will depend on the salary-dividend split for business owners and this means that every penny earmarked towards the owners of the company needs to be planned out in advance as this will make it easier to run your business properly.


Other Small Businesses


If that wasn’t confusing enough, there is another set of rules for other small businesses like restaurants and small manufacturers.  In this case, the new tax rate and the deductions you can take will depend on your payroll as the 20 percent standard deduction is limited to half of your total payroll.  Wow, they sure made this easy, didn’t they?


For example, a company with an annual revenue of $1 million and a payroll of $400,000 can only deduct 20 percent of half of their payroll (i.e. 20% x 200,000).  This works out to $60,000 and while it might not sound like a lot this money can be used to reinvest in the business or to hire more staff.


By the way, some experts claim the above deduction is capped at $200,000 – though you will want to review the details with your accountant to see how this will be applied in your case. 


This is probably the biggest take away for small business owners at this point.  While the IRS is working on guidance for the new rules, there is bound to be revisions and this means that tax planning will be even more important this year.


What Does It Mean?


Only in the U.S. can tax reform mean a more convoluted process for small businesses.  While this is a shame, it does mean that those small business owners who coordinate with their accountants will be best positioned to take advantage of what is on offer.


Another impact is confidence as the news of tax reform has led many small business owners to feel better about the economy.  However, you want to make sure that you don’t count your chickens before they hatch – especially if your business is in a high-cost state like New York or California.


The reality is that businesses in these states will probably end up paying more in state taxes and this could lead to a net loss depending on the final mix of taxes and other fees.  Again, the only way to prepare for this is to talk to your accountant and make sure you clearly understand the new rules of the road.

Finally, another area which could impact millions of small business owners are how the new rules will impact the purchase of equipment.  According to tax experts, the new rules will allow for the business owners to expense the full cost of new equipment in the year it was purchased.  If this is correct, then it would put an end to the practice of depreciating the cost of equipment; however, the full impact will need to be reviewed to make sure it is properly accounted when you do your taxes for 2018.

As you can see there are pros and cons to the tax reform measures and with any change to the tax system, the first year is always the hardest as small business owners and their tax advisors struggle to understand what is happening.


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