Congress is moving quickly on a business tax reform package that will lower corporate tax rates in an effort to encourage investment and make America more attractive for jobs. Both the U.S. House of Representatives and the Senate have approved versions of the “Tax Cuts and Jobs Act of 2017."
There are important differences between the bill passed by the House and the one approved in the Senate. Before any tax reform can become law, the two competing bills must be reconciled into a single piece of legislation, passed by both houses of Congress, and signed by the President. Republicans hope to enact legislation and send it to President Trump before Christmas. If approved, much of the new legislation would impact businesses beginning in 2018.
That makes it important to stay on top of developments and how this tax reform will affect you as a business owner or entrepreneur. Here are some of the key provisions:
Tax rate structure for small businesses. Both the House and the Senate propose a new tax structure for “pass-through" businesses. This includes sole proprietorships, partnerships, S corporations, and most LLCs. Owners of pass-through businesses report their business income on their personal tax return and pay tax at their personal income tax rates, which can be as high as 39.6 percent. The House and Senate bills have different pass-through features, but both versions have been endorsed by the National Federation of Independent Business.
The House bill has a maximum 25% tax rate for pass-through businesses. This won't affect the 85 percent of pass-through business owners who already pay a tax rate of 25 percent or less. But business owners in higher tax brackets will get a tax break.
The House bill has a few additional wrinkles for pass-through businesses:
- Business owners who actively work in their business will only get the 25 percent rate on 30 percent of their business income—the other 70 percent will be taxed at their normal individual rate. Passive investors, on the other hand, can take the 25 percent rate on all their pass-through income.
- People who own businesses that provide a service, including consultants, accountants, and lawyers, aren't eligible for the 25 percent tax rate.
- Small business owners who make $150,000 or less ($75,000 for individual filers) will only pay a 9 percent tax rate on their first $75,000 of income ($37,500 for individual filers). This will be phased in between now and 2022.
The Senate bill allows pass-through business owners to deduct 23 percent of their business income, but the deduction would be phased out for people in professional service businesses earning more than $500,000 (for joint filers) or $250,000 (for individual filers). The deduction would expire in 2025.
Tax rate structure for C corporations. Both the House and Senate bills permanently reduce the top corporate tax rate from 35% to 20%. However, under the Senate version, the tax reduction would not take effect until 2019. The rate reduction benefits all C corporations, whether large or small.
Expensing of capital investments. The House bill allows businesses to immediately write off the costs of investments in new depreciable property, excluding structures, acquired after September 27, 2017 and before January 1, 2023. Under current law, there is some expensing for certain types of business entities under Section 179.
Increased Section 179 limits. Section 179 of the tax code allows businesses to deduct the full cost of qualifying equipment and software in the year it is purchased. Currently, businesses can only deduct $500,000 of these expenses. The House bill would increase the limit to $5 million, while the Senate version would increase it to $1 million. This creates immediate expensing for business expenditures—reducing taxes paid in the year of investment instead of having to spread it out over many months.
Interest expense. For larger corporations and pass-through entities for tax years beginning after 2017, an entity's interest deduction would be limited to 30 percent of the business's adjusted taxable income under the both the House and Senate tax bills. Certain small businesses with average annual gross receipts for the prior three tax years of $25M or less would be excluded.
Entertainment expenses. Currently, business owners can deduct 50 percent of the money they spend on business meals and entertainment. Both the House and Senate propose eliminating the deduction for entertainment, but keeping the meal deduction.
The tax reform legislation is likely to evolve over the coming weeks. As a business owner, it's always important to be aware of changes that could impact your business. Contact your legislators if you want to make your voice heard during this historic process.
LegalZoom is here to assist small business owners and entrepreneurs by keeping you informed. If you have detailed questions about how this tax reform could impact you or your business, consult your tax advisor. If you currently don't have a tax advisor, check out Business Advantage Pro, which offers both legal and accounting advice to assist you with questions on the proposed tax legislation.
The information provided above is all based upon proposals released on the tax reform plan and is not currently enacted into law.