Disclaimer: Invoice2go does not provide tax, legal or accounting advice. This article has been prepared for informational purposes only, and is not intended to be relied on for tax, legal or accounting purposes. You are strongly encouraged to consult your own tax, legal and accounting advisors to determine how the information may relate to you or the specifics of your business.
Tax season is here and you might be wondering how President Trump’s new Tax Cuts and Jobs Act (TCJA) may impact your business’ taxes.
If you are, you’re not alone. While there are plenty of personal tax updates in the 500+ page TCJA, here’s a quick rundown of the biggest changes most likely to impact your small business:
What’s Changing Under the Tax Cuts and Jobs Act (TCJA)?
The TCJA made a major renovation by putting all C corporations into one flat 21 percent tax bracket. But, most small and medium businesses are considered pass-through entities, and there’s a good chance as an Invoice2go customer, you are too.
A pass-through entity is basically anything besides a C corporation where the income is “passed through” to the owners and taxed on their personal returns. Pass-through entities include sole proprietorships, LLCs, S corporations, and partnerships.
New 20 Percent Deduction for Pass-Through Businesses
So, what do pass-through entities get to make things fair? Not that tax codes are always fair but you probably DO get something. Most pass-through businesses will qualify for a new 20 percent tax deduction.
This deduction is relevant for all pass-through businesses, but there are three things to be aware of:
1. Limitation for Specified Service Trade or Business (SSTB)
If your skill, knowledge, or reputation is the main money maker in your business, the IRS may consider your business a Specified Service Trade or Business (SSTB).
Common SSTBs include:
Financial service providers
An SSTB can still qualify for the 20 percent deduction, but only up to a point. It starts to phase out if your income reaches $157,000 (single filer) or $315,000 (joint filers) and disappears after $207,000 (single filer) or $415,000 (joint filer). Check with your accountant to see how much you can claim.
2. The Deduction Phases Out at a Certain Point
If your income exceeds the thresholds above, your deduction could be limited by the amount of W-2 wages paid by your business. This could have a big impact on a business that is carrying a lot of profit and not paying out much in the form of wages to owners and employees.
3. How the Deduction is Calculated
The deduction is 20 percent of Qualified Business Income (QBI), but what exactly is QBI? According to the IRS:
“QBI is the net amount of qualified items of income, gain, deduction and loss from any qualified trade or business. Only items included in taxable income are counted. In addition, the items must be effectively connected with a U.S. trade or business. Items such as capital gains and losses, certain dividends and interest income are excluded.”
Does This Replace Itemizing, Like a Standard Deduction?
The new deduction may feel like the standard deduction you can choose to take on your personal taxes, but it’s not. Rather than replacing your itemized business expenses, this new deduction is taken in addition to your itemized business expense deductions, so make sure you continue to keep track of mileage, office expenses, etc. and use your Invoice2go app to capture those receipts.
Are Itemized Deductions Dead?
You may have heard the rumor that itemizing is a thing of the past since the TCJA essentially doubled the standard deduction. While it’s true that the standard deduction was nearly doubled to reduce the need for itemizing, this is only for personal deduction items.
Deductions for business items are taken on a separate form (Schedule C of form 1040) and can still be itemized and deducted, whether you choose the standard deduction or choose to itemize your personal deductions (which include things like some medical expenses, student loan interest, and charitable donations).
So, you may be able to deduct your business expenses, take advantage of the much improved standard deduction for personal expenses, and claim the new 20 percent deduction for your pass-through business.
And a Bonus!
As exciting as a 20 percent deduction sounds, we thought you could use a little good news bonus. Another major change in the tax law boosts bonus depreciation for new assets put into use by businesses.
Typically, when you purchase a vehicle, equipment, or another big item for your business, you need to depreciate it over several years and take a small deduction each year. Bonus depreciation allows you to take as much as 100 percent of the cost as a tax deduction in year one! This has been limited to 50 percent in previous years but the new TCJA doubled it.
If you made a big business purchase last year, ask your accountant if you may be able to take bonus depreciation. If not, it continues to apply until 2023 which may affect what you plan to purchase this year too.
The rules have also been expanded to allow a deduction for certain building improvements. You may be able to deduct the expense of improvements to nonresidential property, including a new roof, HVAC system, security alarms, etc. Not only is this good news if your building needs work, it should also give a boost in business if your company provides any of these new tax-incentivized improvements.