The new tax law is here. And while there are still many unanswered questions, we only have one on our minds: how do these changes affect small businesses across America?
We’ve talked with a few financial planners to help make sense of the new legislation and how it most directly impacts your business. They also had a few suggestions of items you should discuss with your tax advisors now to take full advantage of the changed law. Let’s jump in.
1 big change: a 20% reduction in small business taxes
Pass through entities such as S-corporations, LLCs, and sole proprietors will all continue to be taxed at the individual tax rates of the owners of these entities. This is how they’ve been taxed in the past—nothing new to see there. That said, individual tax rates have also decreased at every income level, so owners of pass-through entities will also see reduced taxes.
Here’s where it gets interesting for small businesses. The new tax law offers small businesses a 20% tax deduction on all business income earned, with a few exceptions. For example, this deduction is not allowed for businesses that provide advice to a clientele such as CPAs, financial advisors, attorneys, etc.
If you’re uncertain if that applies to you, please consult your tax advisor.
How does it work? Let’s take a hypothetical look:
If an owner has $1 million of K-1 income from their business, they should be able to deduct $200,000 and are only taxed on $800,000 of income. This income will be taxed at slightly lower tax rates since individuals have lower tax rates as well. So this owner with $1 million of income would save just under $100,000 in taxes.
$1,000,000 K-1 income
– 20% deduction (new tax deduction)
= $800,000 of taxable income (new, lower tax rate)
This would save this particular owner nearly $100,000 in taxes.
2nd big change: tax deductions to invest in equipment
There are several other tax deductions hiding in the new law, such as 100% bonus depreciation. It allows business owners to deduct the full amount of new equipment during the tax year, rather than taking a pro-rata deduction over several years.
To put that more simply, small businesses will be able to invest in the tools they need to make their business more efficient and save while they do. And they’ll be able to save that money immediately, not incrementally over the course of multiple years.
Small businesses should see the benefit of these investments immediately, not over the course of several years. Increasing the quality of the tools in the business should help employees be more productive and warrant the raise that also comes with a high-tax deduction for employers.
Many of the most prominent changes are designed to give small business owners breathing room by freeing up more cash now. Owners can invest in their staff, facilities, and put more money back into the businesses as well as the owner(s) of these businesses. With more cash-flow, small businesses will be poised to grow and reach higher levels of success.
5 things to discuss with your tax advisor
That’s all great and all, but how does that translate into a more productive and effective business this year?
Glad you asked.
We had the same question for the tax advisors we consulted for this post. This was their response:
- Upgrade and buy more equipment
If you need new equipment, this might be the year to buy it. You’ll be able to write it off, and because you’re paying less taxes, that money will go further. - Give raises to employees
A great way to reinvest in your business is to give your employees a raise. It will boost morale, keep employees happy, and improve their productivity. Perhaps more importantly, it will increase employee retention. Now that you’re not paying as much in taxes instead of thinning out expenses, you could bulk up and spread the savings across all levels of your business’s operations. - Hire more employees
Again, because you’re paying less in taxes, you’ll leverage your business further. Hiring more employees will help you spread the workload to more employees or take on more revenue-enhancing initiatives. With fewer financial restrictions, you can hire more staff to help bolster the areas of your business that will yield the biggest returns. - Consider paying less in quarterly taxes
As your tax bills go down, you could safely reduce your quarterly tax payments and reinvest the difference that you had been paying back into your business (rather than taking a lump sum at the end of the year). - Invest in the business and its future
Find ways to invest in the long-term goals of your business: employee training, incentives for employee performance, a personal raise, or some of those odd jobs that you’ve not been able to budget for the past few years. The new tax law should increase your cash flow, which means more money to reinvest in the business or more cash in the bank. Talk with your tax advisor about the ways you’ll save, how much, and how you can best use it.
Take action
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DISCLAIMER: We are not tax experts. This post should not be read or taken as tax advice. Rather, we hope it will give you a few things to talk about with your CPA or tax advisor(s).