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Cracking the Code on the Tax Cuts and Jobs Act: How It Will Impact Your Business

Tax Planning for 2018: How Will the New Tax Bill Affect Your Small Business?

Normally at this time of year, individuals and small business owners are solely focused on their 2017 taxes. But with the passage of the sweeping tax overhaul, this is no ordinary year. The Tax Cuts and Jobs Act [1] takes affect starting with your 2018 return and beyond, but the changes are so significant, it’s important to understand the bill and how it will impact your small business.

Tax Planning for 2018

For small businesses, the two biggest changes are the lowering of the tax rate for C Corporations and the 20 percent tax deduction for pass-through entities. Here’s a high level look at both.

20% Deduction for Pass-through Income

The law creates a brand new tax deduction for owners of pass-through entities like sole proprietors, members of LLCs, partners in partnerships and shareholders in S Corporations. For taxable years beginning after December 31, 2017 and before January 1, 2026, these individuals can generally deduct 20% of their qualified business income (QBI) from a pass-through entity. Sounds good, right? And it is — but there are a few details to know:

In short, this new pass-through deduction can be a really nice tax break for those individuals who qualify. If you are not sure how it applies to your business, don’t worry — you’re probably not alone. But, it’s a good time to talk to a tax law professional or tax advisor. And lastly, unlike the corporate tax cut (which is permanent), the pass-through deduction is set to phase out in 2025 (unless Congress extends it).

Corporation Tax Rate Cuts

One of the other big tenets of the Tax Cuts and Jobs Act is the major reduction in the C Corporation tax rate… it was slashed from 35 percent to 21 percent. If you’re structured as a pass-through entity right now, you might be wondering if you’d be better off structured as a C Corp to take advantage of that 21% rate.

But keep in mind that double taxation is still a factor. Simply put, double taxation occurs when income earned by the corporation is taxed at the business level; then, when the corporation distributes income to shareholders, the shareholders are taxed on that dividend. For owners who also expect to take some profit out as distributions, this can mean you’re essentially being taxed twice (first at the corporate level, then at the individual level).

If you are looking to re-invest profits back into the business, then a C Corporation might be the optimal business structure – this has always been the conventional guidance but it’s even more true now with the tax rate at 21 percent. If you are looking to take a bulk of the profits out of the business and put them in your own pocket, a pass-through entity is still most likely better (but you may want to speak with a tax advisor).

The bottom line is this is a good time to think about the tax changes and your business structure. Keep an eye out for when the IRS releases additional guidance. If needed, speak with a tax advisor about your specific situation. And lastly, one of the key reasons to form an LLC or Corporation has always been the ability to minimize the personal liability of business owners from things that happen in the business. This still holds true. The most important reason to form a business entity isn’t necessarily to save a bit on taxes; instead it’s to protect your personal assets for years to come.

Photo via Shutterstock [2]