Bret Curtis has a mixed summary for the Tax Cuts and Jobs Act of 2017: The good, the bad and the ugly.
Curtis, a tax shareholder at Mize Houser, said overall, the act is “generally favorable” to small business owners, who will benefit from a number of provisions in the bill passed by Congress and signed by President Donald Trump in December. But there are some parts of the legislation he’s not crazy about.
“There’s good stuff in this bill, there’s bad stuff in the bill, and then there’s some new complexity that’s just plain ugly, just because of the ways they were trying to write rules and get them through the legislative process,” Curtis said.
Karen Kerrigan, CEO of the Small Business & Entrepreneurship Council, agreed with Curtis’ assessment.
“Overall, the big picture from our perspective is that the new law, in general, is going to be really solid for the economy in terms of generating growth, in generating new investment and new opportunities for small businesses and entrepreneurs to grow their firms. More capital flow in the economy is going to be very helpful for capital formation and a more dynamic economy in general,” Kerrigan said. “There’s just going to be a lot more capital and resources going back to businesses in general.”
However, she’s concerned that many of the provisions in the new bill expire after 2025. Kerrigan said the sunset aspect makes the changes less powerful because businesses can’t plan as far into the future.
Here’s a look at the good, bad and ugly effects the new tax law will have on small businesses.
CORPORATE TAX RATE
The bill lowers the corporate tax rate from 35 percent to 21 percent, with no sunset provision.
Kerrigan is a big fan of this provision for C-corporations.
“There’s a heck of a lot of small businesses that are also C-corps,” she said. The new tax rate “is really going to help them be more competitive and obviously give them a lot more resources to plow back into their businesses.”
Some of the investments she listed included offering higher wages or better benefits, which could give small businesses a competitive edge.
Curtis said the large cut will reinvigorate the debate of whether it’s better for small businesses to organize as a C-corp or a pass-through entity.
“I think the lower C-corp rate has created some envying the Johnsons, so to speak,” he said.
But, he pointed out, C-corp earnings are still subject to double taxation—the business is taxed, and then shareholders are taxed on payouts from the company.
Edwin Hood, a tax attorney at Hood Law Group and Professor Emeritus at the University of Missouri-Kansas City School of Law, said a C-corp arrangement might make sense for companies that do a lot of international business. He said there is a deduction available for cross-border transactions, called the Foreign-Derived Intangible Income deduction, that could lower a company’s tax effective rate to as low as 13.125%.
INDIVIDUAL INCOME TAX BRACKETS
The tax bill changed the income tax brackets for individuals. It widened the income levels over which individual rates are applicable, Curtis said. This is important for any small business organized as a pass-through entity—this applies to S-corporations, LLCs, partnerships and sole proprietorships.
The very top tax bracket now applies to those earning more than $600,000 (for married taxpayers filing jointly). The tax rate at this level is
37 percent. Previously, the top tax bracket was triggered at income of $470,700 (for married taxpayers filing jointly), and the rate was 39.6 percent.
This is a favorable change for most small businesses, Curtis said. However, the reduced rates sunset after 2025.
DEDUCTION FOR QUALIFIED BUSINESS INCOME
One of the biggest changes to tax code, Hood said, is the new deduction for qualified business income.
“What’s interesting about this is the deduction is not what we call an above-the-line deduction, it’s not an itemized deduction, it’s a deduction taken from taxable income itself. So it’s a unique provision that we’ve never had in the code before,” he said.
Here’s how it works: For businesses that opt for a pass-through arrangement, the owner can take a 20 percent deduction on the net income from the business before calculating taxable income.
Curtis gave an example of a retailer that makes $1 million in profit. Before putting that income on a personal tax return, the owner can take a $200,000 deduction—subject to certain limitations—and is taxed at the federal level only on $800,000.
“That sort of revs up this rate reduction,” he said. “That’s a pretty exciting and pretty important part of this bill. It was intended to sort of bring the rate reduction for flow-through business much closer to the decrease in the rates that we saw for C-corps.”
Kerrigan said the new deduction will boost businesses.
“That 20 percent deduction that they’ll be able to use for qualified business income is going to provide all small businesses at least some amount of relief and more capital that they can put into their businesses,” she said.
There’s a big caveat to this rule, though. It doesn’t apply to “specialized service businesses,” which include those in health care, law, accounting, consulting, financial services, brokerage services and some other excluded industries. In these service businesses, owners may
only treat their income as qualified business income if their taxable income is less than $315,000 (for married taxpayers filing jointly).
Curtis explained the reasoning for the exceptions.
“If you had a very service-oriented business, it is harder to separate what is a reasonable wage from what is a return on your investment,” he said.
Hood said the QBI deduction creates some gray areas that will have to get hashed out by the IRS.
“There doesn’t seem to be any clear, definitive answers on a lot of these things that are left open. So the IRS is going to have to regulate a lot, and the question is how that’s going to please Congress,” he said.
The bill changes how businesses can depreciate the cost of property other than real estate. Intangible property won’t be subject
to immediate expensing.
Now, businesses can elect to immediately expense any amount of tangible equipment under bonus depreciation rules, up to a cost of $1 million, Curtis said.
A new wrinkle in this tax code is that it now allows “qualified real property additions” to be immediately expensed, Curtis said. That means interior renovations of an existing, nonresidential building would qualify.
Another change that’s important for small business owners is the new like-kind exchange policy.
Curtis used the example of a business trading in a used, fully depreciated truck for a new truck. In the past, the trade-in value wasn’t considered a gain for tax purposes; now, there will be a recognized gain in that same situation.
“They’ve eliminated those like-kind exchanges for everything except real estate,” Curtis said. “It’s a fairly significant thing to a lot of business owners who did like-kind exchanges because they were able to defer a lot of tax.”
However, Curtis said this might be a wash when combined with the immediate depreciation of capital expenditures, at least for tangible property.
Estate tax changes should be of particular interest to any family businesses hoping to pass the torch one day.
The new tax bill raises the lifetime limit for passing on a gift or estate. The limit doubled to about $11.2 million per person, adjusted for inflation. This will allow more small businesses now to pass on their companies. However, the provision sunsets in 2025, so start succession planning now.
“For a period of time here, we have a lot of flexibility for small biz owners—and actually, even mid- to larger biz owners could pass without concern of estate tax,” Curtis said.
OTHER NOTABLE CHANGES
The experts pointed out a few other changes taxpayers should keep in mind:
Net operating loss provision // Going forward, net operating losses can be deductible for up to 80 percent of taxable income; they can be carried forward but not carried back.
Hood said carrying back net operating losses was an averaging technique used to mitigate the annual reporting system. He called the new provision “bad policy.”
Moving expenses // People moving for a job can no longer write off their moving expenses, Hood said. Only members of the U.S. military retain this benefit.
Stock options // Kerrigan said she is a fan of a provision that hasn’t gotten much attention. It’s a change to how stock options are taxed, and she said it could have important ramifications for startups and high-growth businesses.
Previously, if employees exercised stock options, they were required to pay taxes immediately—but they often lacked the ability to do so. That potentially presented a barrier for some qualified employees to join a startup.
Now, she said, the taxes are due in five years or when the company becomes publicly tradeable. That will help startups attract and retain the employees they need to grow and scale, she said.
What all of the experts interviewed agree on is that the bill makes the tax code more complicated. That’s a big concern for Kerrigan and the SBE Council.
“For the small business person, that simplicity piece really is a missed opportunity,” she said. Kerrigan said the SBE Council will continue to work with Congress on the Small Business Tax Code Simplification Act. She said the act provides opportunities to make technical changes and modernize certain aspects of the tax code that don’t “cost” anything to the Treasury but make the code less complex from a compliance standpoint.
Lenexa Firm Survives Close Call with Tax Reform Negotiations
One area small business was keeping a close eye on recent negotiations leading to the Tax Cuts and Jobs Act of 2017.
Some early versions of the bill drafted by Congress were “super problematic” for the wind and solar industries, said Rob Freeman, CEO of Tradewind Energy in Lenexa. The suggested changes revolved around diminishing the value of Production Tax Credits, the industry’s primary investment tool, or eliminating them immediately.
Those changes would have been a big problem for Tradewind Energy, one of the largest wind and solar project development companies in the U.S.
“The fact that the House would basically say, OK, well, we’re going to just shut that program down after we all agreed that there was going to be a steady ramp down over five years is just unbelievable,” he said. “These are the same people who always talk about importance to business of having a stable regulatory and policy environment so you can run your business. So it just flew in the face of all that.”
In the end, the final bill resulted in no change to the previously negotiated phase out of the tax credits—those will still expire at the end of 2020.
But other parts of the bill have the potential to negatively impact the wind and solar industry, Freeman said. The flagship provision of the bill, the reduction of corporate taxes from 35 percent to 21 percent, damages the economics of wind projects, he said.
An important aspect of the economics of these projects is the depreciation, Freeman said, which has less value under a lower corporate tax rate. In order to hold project returns, prices may have to increase.
This is a tricky area that companies with pending transactions will have to navigate—for projects that are already bid or under construction, it may be difficult to decide what to do now that the return on investment won’t be the same as was expected.
“That has been the most difficult thing for the industry to react to—what is the end effect of the pricing of wind power, and are there ways to mitigate that? So the industry’s sort of been in a scramble trying to figure that out,” Freeman said.
But going forward, companies will know what to expect when planning a wind or solar project, Freeman said. And that will keep his company of 140 employees moving ahead.
“We’ll keep trucking along. Both Production Tax Credits and Investment Tax Credits (for solar projects) are going to ramp down over the next few years, but the industry is planning on that.
“Big picture, I think the industries will be OK.”