Changes to Tax Laws Impacting Small Businesses

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Small businesses have always played a crucial role in the economy, providing employment opportunities and driving innovation. However, with the ever-changing landscape of tax laws, it can be challenging for small business owners to keep up with the updates and understand their impact on their operations. The recent changes in tax laws have brought about significant changes that directly affect small businesses. In this blog post, we will discuss these changes and their implications for small businesses. We will also provide strategies for small businesses to adapt and thrive in this new tax environment.

Overview of the New Tax Laws

In December 2017, President Trump signed into law the Tax Cuts and Jobs Act (TCJA), which is considered the most comprehensive reform of the US tax system in over 30 years. The TCJA brought about significant changes to the tax code, affecting both individuals and businesses. Some of the key changes include a reduction in individual and corporate tax rates, an increase in the standard deduction, and changes in the treatment of pass-through entities.

One of the most significant changes impacting small businesses is the reduction in corporate tax rates. Before the TCJA, corporations were subject to a maximum tax rate of 35%. However, under the new law, the corporate tax rate was reduced to a flat rate of 21%. This reduction in tax rates has resulted in significant tax savings for corporations, allowing them to invest more in their business operations.

Another essential aspect of the tax reform was the introduction of a new deduction for qualified business income (QBI) for pass-through entities. Pass-through entities, such as partnerships, S-corporations, and sole proprietorships, do not pay taxes at the entity level. Instead, the profits or losses are passed through to the owners and taxed at their individual tax rates. Under the TCJA, qualifying pass-through entities can now deduct up to 20% of their qualified business income from their taxable income. This deduction can result in substantial tax savings for small businesses.

Moreover, the TCJA also made changes to various deductions and credits available to businesses. For instance, the law limited the deduction for state and local taxes (SALT) to $10,000 per year. It also eliminated the domestic production activities deduction and introduced new limitations on the net operating loss (NOL) deductions.

Impact on Small Businesses

Changes to Tax Laws Impacting Small Businesses

The changes in tax laws brought about by the TCJA have had a significant impact on small businesses. While the reduction in corporate tax rates has been beneficial for C-corporations, most small businesses are structured as pass-through entities. The introduction of the QBI deduction has provided some relief for these businesses, but it has also created complexities and uncertainties.

One of the major challenges for small businesses is understanding the eligibility criteria for the QBI deduction. To be eligible for the deduction, the owner’s taxable income must be below a certain threshold. For 2021, this threshold is $329,800 for married filing jointly and $164,900 for single taxpayers. Additionally, specific industries, such as health, law, accounting, and consulting, are subject to further restrictions on the QBI deduction. These complexities make it challenging for small business owners to determine their eligibility for the deduction accurately.

Moreover, the limitation on SALT deductions has also affected small businesses, especially those located in high-tax states. The cap on SALT deductions means that business owners may not be able to deduct all of their state and local taxes paid, resulting in higher taxable income and potential tax liabilities.

Another area of concern for small businesses is the changes to the NOL deduction. Before the TCJA, businesses could carry back NOLs for two years and carry forward NOLs for up to 20 years. However, under the new law, NOLs can no longer be carried back, and the carry-forward period is limited to 80% of the business’s taxable income in the year of the NOL. This change can have a significant impact on small businesses that rely on NOLs to offset their tax liabilities.

Strategies for Small Businesses to Adapt

Changes to Tax Laws Impacting Small Businesses

With the changes in tax laws impacting small businesses, it is crucial for business owners to understand these changes and adapt accordingly. Here are some strategies that small businesses can implement to navigate the new tax landscape:

Consult with a Tax Professional

The first and most important step for small business owners is to seek advice from a tax professional. With the complexities surrounding the new tax laws, it is essential to work with a qualified tax advisor who can help you understand your tax obligations and identify potential opportunities for tax savings. A tax professional can also assist with tax planning, ensuring that your business is structured in the most tax-efficient manner.

Review and Update Your Business Structure

The reduction in corporate tax rates and the introduction of the QBI deduction have caused many small business owners to reconsider their business structure. While C-corporations may now be more attractive for certain businesses, it is essential to consider all factors before making any changes. For instance, C-corporations are subject to double taxation, meaning that profits are taxed at the corporate level and again when distributed to shareholders as dividends. On the other hand, pass-through entities allow for single taxation, where profits are only taxed at the individual level. Therefore, it is crucial to evaluate your specific business’s financial and tax situation before deciding on a business structure.

Take Advantage of Available Deductions and Credits

While the TCJA made changes to various deductions and credits, there are still plenty of opportunities for small businesses to reduce their tax liabilities. For instance, businesses can take advantage of the Section 179 deduction, which allows for the immediate expensing of qualifying assets, such as equipment and machinery. Additionally, businesses can also claim the research and development (R&D) tax credit, which provides a dollar-for-dollar reduction in taxes for qualified R&D expenditures.

Plan for Future Tax Changes

The TCJA is not the only tax reform that small businesses may have to adapt to in the future. It is essential to stay informed about any potential changes in tax laws and plan accordingly. For instance, recent proposals have been made to increase corporate tax rates and impose higher taxes on high-income individuals. These potential changes could have a significant impact on small businesses, and it is crucial to plan ahead to minimize any potential negative effects.

Case Studies or Examples

To better understand the impact of the changes in tax laws on small businesses, let’s look at some real-life examples:

Example 1: Mary’s Bakery

Mary owns a small bakery and operates as a sole proprietorship. In 2019, her net income from the business was $150,000, and she paid $25,000 in state and local taxes. Before the TCJA, Mary could deduct the full amount of her state and local taxes on her federal tax return. However, under the new law, she can only deduct $10,000, resulting in a $15,000 increase in taxable income.

Moreover, Mary’s bakery has been struggling due to the pandemic, resulting in a loss of $50,000 in 2020. Under the old tax laws, Mary could carry back this NOL to 2018 and receive a refund of taxes paid in that year. However, with the TCJA changes, she can no longer do so and must carry forward the NOL to offset future income. This change means that Mary will have a higher taxable income in 2020, resulting in a potential tax liability.

Example 2: Mark’s Consulting Firm

Mark owns a consulting firm that generates $500,000 in net income annually. Under the old tax laws, Mark’s effective tax rate was 29%, resulting in a tax liability of $145,000. With the reduction in corporate tax rates to 21%, Mark’s tax liability would decrease to $105,000. However, Mark’s business is subject to the restrictions on the QBI deduction due to his industry, limiting his deduction to 50% of W-2 wages paid or 25% of W-2 wages plus 2.5% of the unadjusted basis of depreciable property. Based on these limitations, Mark can only deduct $75,000 from his taxable income, resulting in a higher tax liability of $120,000.

Conclusion

In conclusion, the changes in tax laws brought about by the TCJA have had a significant impact on small businesses. The reduction in corporate tax rates and the introduction of the QBI deduction have provided some relief for certain businesses, but they have also created complexities and uncertainties. It is crucial for small business owners to seek advice from tax professionals and stay informed about any potential changes in tax laws. With proper planning and adaptation, small businesses can continue to thrive and contribute to the economy.

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