See if your business stands to benefit from the Tax Cuts and Jobs Act.
The recently passed tax plan contains some amazing new incentives for business owners and investors. While it was touted as a middle class tax reduction, the tax plan primarily benefits entrepreneurs and corporations. Here are the top 10 ways to benefit from the incentives added by the Tax Cuts and Jobs Act.
The depreciation deduction for business automobiles has been the same for decades. Years ago the IRS decided that any car over $15,000 was a luxury car. Depreciation on cars that cost more than this would be limited to the amount that would be paid for a $15,000 car. The result was that a car that cost $35,000 would be depreciated over more years than the car would last.
Congress corrected this in its new tax plan to adjust both for inflation in the intervening years as well as for inflation in ensuing years. Beginning in 2018, business automobiles can be depreciated at $10,000 for the first year, $16,000 for the second year, and $9,600 for every other year until fully depreciated.
Most business owners are aware of the bonus depreciation that has been in and out of the tax law over the past several years. Beginning with purchases after September 27, 2017, 100 percent of equipment can be depreciated in the first year of ownership.
And under this new tax plan, it’s not just new equipment that qualifies: used equipment also qualifies for the 100 percent deduction the first year.
This also means that purchases of trucks and SUVs with a GVW (gross vehicle weight) in excess of 6,000 pounds are deductible in their entirety as soon as they are purchased.
Section 179 deduction
Not only did they increase the Section 179 deduction for equipment purchased by small businesses to $1 million but they also expanded it to include many expenditures that aren’t usually thought of as equipment and that do not qualify for the bonus depreciation.
The first tax plan expansion was to include residential rental properties. Previous law limited the deduction for purchases made by owners of rental properties. The new law allows the deduction without any limits other than the normal limit of net income.
The second expansion was to include roofs, HVAC units, fire alarms, and security devices in the definition of what qualifies for the Section 179 deduction. Plus, leasehold improvements qualify for the deduction whether they are paid for by the landlord or the tenant.
This one is pretty interesting. Alimony has long been deductible to the spouse paying it and taxable to the spouse receiving it. This benefit continues, but ONLY if the divorce is finalized in 2018. (There must have been some senator in the middle of a divorce that wouldn’t be finalized until this year.) So anyone who is planning to get divorced soon should make sure the divorce is completed in 2018 if they are paying alimony. If they are on the receiving end, they may want to delay the divorce until 2019.
21 Percent Corporate Tax Rate
One incentive that received a lot of press during deliberations of the tax plan is the reduction in the corporate tax rate from a maximum of 35 percent to a flat rate of 21 percent. This will not only be important to big companies. Smaller companies, especially professionals that do not qualify for the 20 percent pass-through deduction (nextpage) may want to consider changing from an S corporation or a partnership to a C corporation. This is especially true if the owners plan on reinvesting a large portion of the profits back into the business.
20 Percent Pass-through Deduction
Perhaps the most complex of all the new tax plan incentives is the deduction for pass-through entities such as S corporations, partnerships, and sole proprietorships. On the surface, it’s very simple. Take the net income from the company and multiply it by 20 percent. That’s the deduction.
However, there are many limitations to the deduction. For example, professional service companies, like doctors, lawyers, and accountants—though not engineers or architects—don’t get the deduction unless their taxable income is less than $157,500 ($315,000 on a joint return).
In addition, there are other limitations such as the deduction cannot be greater than 50 percent of W-2 salaries or, if more, 2.5 percent of assets. Pretty confusing already, and more confusion is coming as the IRS determines which companies don’t qualify at all because their income is a result of an employee’s or an owner’s “reputation or skill.”
$12,000 Standard Deduction for Kids
Children who work for their parents’ company (or any other company for that matter) can now earn up to $12,000 without paying any tax. If that doesn’t create an incentive for parents to put their children to work, nothing will.
Estate Tax Exclusion
Most people realize that the estate tax exclusion doubled from $5 to $10 million for individuals and from $10 to $20 million for married couples. What most people don’t realize is that there is a terrific income tax benefit that comes with this new exclusion.
In the past, many business owners and investors would plan to reduce their estate taxes by transferring property to their children through trusts and other complex mechanisms. The cost of doing that though was always an increase in income tax to the kids when they sold the business or investments. Here is how this works.
When you die, the gain in your business and all of your investments disappears in what is referred to as a “basis step up.” If you own depreciable property, like real estate, your heirs get to start their depreciation all over again. However, if you transfer the property during your lifetime, you don’t get this benefit. Now, with a $10 to $20 million estate exclusion, you can keep up to that amount of assets in your estate and get the basis step up when you die.
State Tax Credits
Many states give their residents a state tax credit for money donated to certain organizations such as welfare charities or private school tuition organizations. When you make the donation, the state gives you a credit for 100 percent of the donation up to a certain limit. In addition, you get a charitable deduction on your personal income tax return.
This didn’t use to be a big deal. After all, you were just trading a state tax deduction for a charitable deduction. Now that the state tax deduction is severely limited, you may actually come out ahead financially (and certainly feel better) when you give money to these designated charities. This is sure to boost the donations in those states that have such credits.
Small Business Stock
For many years, entrepreneurs have been able to start a business as a C corporation and then sell the stock with zero tax on the gain, so long as they held the stock for more than five years. Very few companies took advantage of this incentive because the corporate tax rate was so high (35 percent plus an additional tax on dividends).
Now that the corporate tax rate is reduced to 21 percent, more startups should consider starting as a C corporation to take advantage of this amazing tax benefit when they sell.
These are just a few of the amazing tax incentives enacted by Congress at the end of 2017. Entrepreneurs and investors: rejoice!
Tom Wheelwright is a leading wealth and tax expert, bestselling author of Tax-Free Wealth, Entrepreneur magazine contributor, Founder of ProVision, and CEO of Tax-Free Wealth CPAs. Tom is best known for making taxes fun, easy, and understandable, and specializes in helping entrepreneurs and investors build wealth through practical and strategic ways that permanently reduce taxes. As a Rich Dad Advisor to Robert Kiyosaki (Rich Dad Poor Dad), Tom frequently speaks at conferences worldwide on these topics.