This is part one of a three-part series outlining the critical changes impacting small and medium-sized businesses as a result of new tax reform legislation. Part one of this series focuses on the generalities, concepts, and key new provisions from a macro perspective. Part two focuses on business implications. Part three examines the impacts to individuals, their families, and their estates.
Tax laws and policies are far more complicated than necessary. Period. Regardless of how you feel about taxes, all members of our communities are obligated to contribute their fair share. As tax advisors, we guide our customers as they navigate the complex world of tax compliance.
Sometimes these journeys are like a slow meandering river and other times it is akin to running a class V rapid. With the passage of the recent tax reform act, the Tax Cuts and Jobs Act of 2017, our tax landscape has been uprooted and, in many ways, violently changed.
Change is good. Revolutionary change is chaotic and unnerving. This new tax legislation has created tectonic shifts in traditional planning. The shifts impact corporations, pass-through entities including partnerships and S-Corporations, sole proprietorships, professional service organizations, individuals, families, and estates.
Candidly, this is the “most sweeping tax reform since 1986,” and in fact, makes some massive changes in how many Americans will be taxed. It should be noted that as sweeping as the reform is, within its first sixty days, there have already been changes. So, strap your seat belt on tight and prepare for a wild ride as we all traverse our new tax landscape.
The “Act” is full of unique provisions. First, many provisions are “temporary” and expire in ten years. These expiring provisions were necessary to meet budget deficit limitations. These changes are forecasted to add $1.5 trillion to our accumulated deficit.
Additionally, while the laws were passed, the implementing regulations will require years to move through the Internal Revenue Service system and accordingly, you and your tax advisor will need to apply judgment to address many of these changes to your situation and any changes to your business financial planning.
For traditional C-Corporations, the tax rate becomes a flat 21 percent rate. This is a dramatic reduction from the previous 35 percent rate. Also note that unlike many of the individual changes, the Corporate changes are permanent. Permanence though in tax legislation is frequently short-lived.
Pass-through entities including most partnerships, LLCs, and S-Corporations, receive a 20 percent reduction of their taxable income. This means if your business generates $100,000 in regular taxable income, you’re taxed on only $80,000 of that income. Note, professional service enterprises including accountants, lawyers, medical professionals and similar enterprises are excluded from many of these benefits.
Bonus depreciation is now unlimited. Expensing equipment purchases under Section 179 limit has increased to $1 million. Real estate depreciation will be accelerated along with increases for limits on vehicles.
Tax reform challenges
- Entertainment expenses are no longer deductible. All entertainment including when direct customer contact and business is procured.
- Tax-deferred exchanges are now limited to real estate transactions. Other traditional like-kind exchanges, including trading in a business vehicle when purchasing a new one, are no longer qualifying. Accordingly, taxes will be applicable in these circumstances.
- Individuals will see changes as well. While rates are lowered across the board, the most significant changes include the nearly effective removal of AMT for most taxpayers.
- State and local taxes, including property taxes, will be limited to $10,000 per year. For high tax states including California, New York, New Jersey, and similar states, this will reduce your itemized deductions and hence raise your taxes.
- Other changes are that investment expenses, job-related expenses, IRA fees, other miscellaneous itemized deductions are no longer allowed.
- Mortgage interest will be limited to $750,000 of qualified mortgages. Pre-Act mortgage limits of $1,000,000 will remain; however, future refinancings will need to be carefully crafted to avoid losing deductions.
- Personal exemptions no longer exist, so large families will feel an impact. An offset to this reduction in benefits is that the standard deduction is significantly raised.
Ultimately, most families will see a net reduction in their overall tax obligations. Qualifying child tax credits have increased to $2,000 and a new non-child dependency credit of $500 is allowed. Remember a tax credit is a dollar for dollar reduction in taxes owed whereas as a tax deduction is a marginal benefit based upon your tax bracket.
Estate tax exemptions may be one of the most significant benefits under this new Act. The estate exemptions have doubled to $22 million for a couple. This is a tremendous opportunity for closely held family businesses as these new limits are certainly subject to revision with little or no warning as Congress and the White House further reconcile deficit impacts.
Ultimately there are many benefits and some deep challenges associated with this new law. For some industries, what was known for a generation is now unknown. For others, like real estate development, what were excellent opportunities have been greatly enhanced.
What you can do now
The best business financial planning is an active conversation with your trusted advisors.
- Ask questions.
- Perform your own research.
- Seek answers from those that know and from those that think.
No one has true expertise in this new law and that is both an advantage and a challenge. The best advisors are rolling up their sleeves to help their customers take full advantage of the opportunities while avoiding its pitfalls.
Now, go forward, breathe some fresh air and look to leverage the opportunities provided and create your own best tax-based future.
2021 Business Tax Calendar
Don't miss important deadlines - and ensure you use the correct forms with this calendar showing key dates in the general tax, employer's tax, and excise tax year for 2021.