Small business owners are examining how the new tax law affects their companies and employees, and whether they need to make any changes in 2018 to adapt to the new regulations passed by Congress in December 2017. Many of these new provisions grant further deductions and may be advantageous for business owners.
According to a recent poll conducted by Insureon, a Chicago-based insurance provider, along with business networking site Manta, a large number of entrepreneurs believe the tax bill will impact their company positively. The survey found that 83 percent said the new tax changes will help their businesses—out of that number, 38 percent said they will hire more employees, 28 percent plan to invest in new technology or research and development to expand their companies, 13 percent will give bonuses, and 10 percent will offer new employee benefits such as healthcare and retirement plans. The survey also found that 80 percent of the entrepreneurs support the bill.
The Brookings Institution, a Washington, D.C. nonprofit public policy and research organization, said 95 percent of businesses are pass-through entities, which means the businesses are not subject to income tax. The new tax law allows for 20 percent of a pass-through business' net income to be deducted from taxes.
With lower tax rates, small business owners who make quarterly tax payments to the IRS based on their estimated revenue should discuss adjusting their installments with their CPA, says Chris Colyer, a partner in the tax services group at WISS & Company, a Livingston, N.J.-based accounting firm.
Allocating the extra revenue into the company’s 401(k) plan or IRA will be the most beneficial because small business owners will not only have the additional retirement savings, but could leverage the tax savings. Funding higher retirement contributions for employees will also provide a tax advantage.
“Owners who put the extra money into a checking or saving account will not get the tax benefit,” he said.
Instead of spending the extra income by expanding the business, owners should tread carefully and wait several months or longer before making any big decisions, Colyer recommends.
“Don’t rush to make some quick decision, since this is the first time having the windfall,” he said.
The 20 percent deduction will free up funds for companies to follow through with other initiatives, or just increase their profits, said Paul Jacobs, a certified financial planner, enrolled agent and chief investment officer of Palisades Hudson Financial Group, based in its Atlanta office.
“This affects independent contractors and sole proprietors, and in turn helps the middle class,” he said.
Tax laws in the past have always encouraged companies to incur debt financing because the interest expense was fully deductible, said Colyer.
“If you had your druthers, as a founder or a president of company, you would have more debt than equity to lower your taxes,” he said.
The trend has now shifted since the new tax law has capped deductions for the interest expense on debt. The cap on deductions include SBA loans and mortgages on real estate, but only affects small businesses that generate average gross receipts of at least $25 million for the past three years.
Companies now can only deduct only a portion of their net interest costs or 30 percent of earnings before interest, taxes, depreciation and amortization (EBITDA). There are no exceptions to this clause, such as debt obtained before the tax law passed.
“Now for the first time, the tax bill is putting a limit on the amount of interest that can be deducted and is swinging the pendulum back to equity,” Colyer said.
The change makes incurring debt more expensive, and the government is no longer encouraging companies to obtain higher levels of debt, he said.
“This is a disadvantage for highly leveraged companies and puts a damper on utilizing debt,” Colyer said.
In the past, when companies bought new equipment, they had to spread out the costs of depreciation over several years.
Now the tax law allows companies to deduct 100 percent of the cost in the first year. The change is beneficial for companies and encourages capital equipment purchases, such as a new $100,000 oven, 3-D printer, or even property.
“If companies buy new equipment, they can take big tax deductions and reduce the taxes they pay,” Colyer says.