PROTECTING SMALL BUSINESS, PROMOTING ENTREPRENEURSHIP

High Hopes for Tax Reform: What It Means for Small Businesses

By at 25 January, 2017, 11:55 am

 

By Barbara Weltman-

President Trump promised tax reform, and Congress is poised to deliver on that promise. The final package will likely be the product of much debate, compromise, and tweaking. Small business owners should follow the process and stay up-to-date with SBE Council’s work in this area (sign up for Small Business Insider weekly enews here) to better plan for the coming year, and beyond.

Here are some of the key points under consideration that would impact small businesses.

Rate Cuts

More than half of all business income in the U.S. is earned by pass-through entities (S corporations, partnerships, and limited liability companies) and sole proprietorships, so the taxes they pay will have a big impact on the economy. How much will your profits be taxed after tax reform is enacted? The precise tax rate is unknown, but probably will reflect the sentiments of the President, who proposed a 15 percent business tax rate on the campaign trail, and Ways and Means Committee Chairman Kevin Brady (R-TX), as expressed in the Better Way tax plan, also referred to as a blueprint for tax reform. Under the blueprint, while the top tax rate for individuals would be 33 percent, the rate on business income for small business owners would be capped at 25 percent.

Small business owners would also benefit from other tax changes for individuals, including:

• Repeal of the alternative minimum tax (AMT) (not referenced in the Trump plan but part of the blueprint).

• Repeal of estate tax (both Trump and the House plan agree on this).

While the proposed tax rate cut for small businesses owners is dramatic and welcomed, it remains higher than the proposed top rate on C corporations under the blueprint, which would be 20 percent.  But we must also remember that many small businesses are C corporations. According to Census Bureau data, 86.4 percent of C corporations have less than 20 employees. Again, President Trump has proposed the same top rate for business income, regardless of how that business is organized (15 percent on C corporations and pass-through entities).

Border Adjustability

The amount of tax paid through these tax rates depends, of course, on the tax base. One of the proposals in the blueprint would be “border adjustability,” which would effectively provide an export penalty and an import subsidy to a destination-basis tax system. President Trump first expressed opposition to this GOP blueprint proposal due to its “complexity,” but it is still under discussion.

Under this scenario, tax jurisdiction is tied to the location of consumption rather than the location of production. In basic terms, this is done by exempting exports and taxing imports. These changes are referred to as border adjustability intended to incentivize “made in the U.S.A.”

The reason for border adjustability is to counter the border adjustments that U.S. trading partners have built in to their valued added tax (VAT). According to the blueprint:

“This means that products, services and intangibles that are exported outside the United States will not be subject to U.S. tax regardless of where they are produced. It also means that products, services and intangibles that are imported into the United States will be subject to U.S. tax regardless of where they are produced. This will eliminate the incentives created by our current tax system to move or locate operations outside the United States. It also will allow U.S. products, services, and intangibles to compete on a more equal footing in both the U.S. market and the global market.”

It is anticipated that retailers—large and small—would feel the impact of border adjustability the most. Many trade groups, including the National Retail Federation, have argued against this tax change, expressing concerns about “fairness.” For example, in some cases, small businesses may be importing items, such as local handicrafts, that have no U.S. equivalent. Of course, these businesses would benefit from the other tax changes, including rate reduction, full business expensing, and retaining the last-in-first-out (LIFO) method of accounting for inventory. Economist also say such a change would benefit the value of the dollar, a plus for retailers.

Expensing

Currently, if you buy equipment for your business, you face a variety of options on how to write-off the cost, including first-year expensing, bonus depreciation, regular depreciation, and a special de minimis safe harbor rule. Each rule has limitations and special eligibility rules, including separate rules for vehicles, that all combine to limit and confuse how to handle the costs from a tax perspective.

Under the blueprint, the cost of equipment purchases would be immediately deductible. This not only eliminates confusion but also simplifies recordkeeping and gives businesses the tax break in the year of the expense.

Research & Development

While tax credits for businesses would largely be eliminated, the research credit would be retained. It is designed to encourage investment in research and development. And currently, small businesses with no profits can use the credit to offset the Social Security tax portion of employer’s share of FICA.

Net Operating Losses

Businesses aren’t necessarily profitable in every year and, under current law, can use a net operating loss to offset income in some prior and future years. The House plan would end any net operating loss carrybacks but would permit them to be carried forward indefinitely. However, the carryforward would be capped at 90% of the taxable income in the carryforward year (without regard to the carryforward).

Conclusion

Again, the precise details of the “consensus” tax reform between GOP leaders and the White House are still being negotiated. Also unclear is the time line for implementation of specific changes (e.g., whether the corporate tax rate will be cut before any changes are enacted for individuals). Most importantly from a planning perspective, it is unknown when any tax changes will take effect. Current tax rules may be in place for all of 2017, or perhaps even longer, and that is why it is important to stay glued in to these developments so you can plan accordingly.

Barbara Weltman is a member of SBE Council’s advisory board, and has been a premier consultant for small businesses of every kind for over twenty years. She’s the founder of Big Ideas for Small Business and has written numerous books on small business operations, including J.K. Lasser’s Small Business Taxes, The Complete Idiot’s Guide to Starting a Home-Based Business, and The Rational Guide to Building Small Business Credit. Follow Barbara on Twitter @BarbaraWeltman

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