November 27-December 11, 2017: Volume 32, Issue 13
By Steven Feldman
Tax reform. You’ve been hearing about it since pre-election 2016. Now it is virtually assured as it moves from rhetoric to reality. I’m not here to debate the pros and cons of it, especially considering a final bill has not yet landed on the President’s desk. But as the publisher of the industry’s leading trade magazine, I felt it was our duty to outline what it might mean for you, our readers, many of whom are small business owners.
This isn’t about the “1%-ers” and middle class. The sole purpose of this editorial is to explain, as I understand it, what this means for the small business owner. The House and Senate still need to reconcile some details, and Congress is scheduled to adjourn for its Christmas break Dec. 15. But House Speaker Paul Ryan has said he will keep the House in session beyond that date if necessary to get tax reform passed.
First, the Senate bill allows owners of so-called “pass-through” businesses (profits are passed through to the owners, shareholders and partners) to deduct 23% of their earnings, and then pay at their personal income tax rate on the remainder. According to the Tax Foundation, 90% of small businesses are set up as pass-through entities, not corporations. You will also still be able to take advantage of deductions for capital expenditures and tax credits for research, development and hiring.
The 23% deduction would be prohibited for anyone in a service business—except those with taxable incomes under $500,000 if married ($250,000 if single).
There are mechanisms in place to prevent abuse of the pass-through tax break. For example, if the owner or partner in a pass-through also draws a salary from the business, that money would be subject to ordinary income tax rates. But to prevent people from reclassifying their wage income as business profits to get the benefit of the pass-through deduction, the Senate bill would automatically limit the deduction to half of the W-2 wages of the pass-through entity or its share to the individual taxpayer. The W-2 rule would not apply, however, if the filer’s taxable income is under $500,000 if married ($250,000 if single).
What about corporate tax rates? Like the House bill, the Senate bill cuts the current 35% rate to 20%, but the Senate bill calls for a one-year delay in dropping the rate. Whether this happens immediately or one year down the road is to be determined. The delay would reduce the cost of the measure in the first 10 years.
Now, as a small business owner, you might not appreciate the fact that big corporations are getting a bigger tax break. In addition, the House is giving those companies hoarding their billions overseas a chance to bring that money back to the U.S. at a 12% taxation rate. That’s great for big companies, yes, but it’s also good for small businesses.
Why? Because small businesses need big businesses for their growth and income. Big companies hire small businesses to do all sorts of things. Big companies also employ people who—when times are good and their salaries are increasing—go home and buy pizzas, hire landscapers, shop for clothes and shower the small businesses—like yours—in their community with the fruits of their disposable corporate incomes.
When tax rates go down, big companies have more options with their money. They can hire people. Will they? Some will and some won’t. But even if they just bank their tax savings, those funds will get deposited with financial institutions who then finance loans and services back to individuals and small businesses. That’s how small businesses benefit from the tax breaks given to large corporations.
One final thought: Before you think now is the time to go out and buy yourself that fiery red Ferrari as a Christmas present, put the brakes on. Any changes will not have any impact on your taxes for 2017, which are due to the IRS by April 17, 2018. Your only gift right now is you get an extra 48 hours to file because the traditional April 15 due date falls on a Sunday.