You may have recalled towards the end of 2017 there was a lot of tax talk. Rightfully so, we often see changes in the tax code, but this bill passed the most extensive reform in over 30 years. Suddenly, every politician and journalist was an experienced economist and accountant. Some argued it would decrease taxes and create jobs, while others thought it was merely benefiting big businesses and hurting the little guy.
Ok – So is it good or bad?
It is too soon to say whether this bill has helped or harmed the economy. What we can say though is that it may provide a positive impact based on how it helps businesses. The idea is that when business taxes are cut, they will have more cash to expand and hire more people. The opposition argues that businesses will instead hold onto this cash, pay more to their current employees, or expand overseas.
This bill can very well help your business. On a personal level, it may harm some. Either way, it is our job as accountants to work within the standards of the tax code to help put you and your business in the best position possible.
Don’t Touch My Income
It almost feels like everything surrounding taxes is a struggle. Income tax might as well be a four-letter word. The tax code sounds like it was written in alien and where are my tax dollars going? This is a lot to unpack, but let’s start with the basics. What is income and how is it taxed?
There are three bodies of government that can apply taxes. Local, State, and Federal governments can all apply tax on your various sources of income. These taxes can apply to both individuals and corporations.
While most of your income can be taxed, you can bring the percentage down with deductions, adjustments, and credits.
A basic rule to follow is, all income is taxable unless specifically excluded. This can be a challenge if you are not sure how income is defined. So let’s begin by checking out the following outline to give you an idea of what is taxable income. This will provide an understanding of what you could be taxed on.
1. Ordinary Income
The most common type of income you will come across. Ordinary income can be taxed up to 37%. You will be able to enter this income on the first page of a 1040 tax form.
- Wages and Salaries
- State/Local Tax Refunds
- Pension Amounts
- Self-Employment Income
- Other income – does not fall into any of the categories listed
2. Portfolio Income
Taxed at various rates depending upon a number of factors. You will be able to report this income on the first page of a 1040 tax form and Schedule B for more significant amounts.
3. Passive Income
Taxed similar to ordinary income. If you have passive income, it can only be offset by passive losses. All your losses can also offset ordinary or portfolio income in later years. You will be able to report this income on the first page of the 1040 form and Schedule E.
- Income earned from activities you did not actively participate in – i.e. income from renting out real estate or interest from financial assets.
4. Capital Gains Income
Any losses can offset other sources of income but only up to $3,000 per year. Capital gains income can be taxed up to 20%.
- Sales of a capital asset – typically any property
Ok, let’s take a deep breath because that was a lot of tax talk. It is important to have a basic understanding of what is taxable so you can understand the new tax bill a bit better. Just know that while this may be overwhelming, a CPA can help make this a smooth process.
Below you will find two sections that break down the bill. The first section lists the changes that could affect you as an individual. The second section covers how the bill could affect you as a business owner.
Reminder: Not all businesses are taxed directly. If your business is considered a corporation or C-Corp your business entity will be taxed. Partnerships, Limited Liability Companies (LLC), S-Corporations, and Sole Proprietorships are all considered “pass-through” entities. This means the taxable income is passed onto the owners, members, partners, or shareholders, who then report the income on their returns.
Part 1 – What Does The Tax Bill Mean For You as an Individual?
Change #1 – Standard and Itemized Deductions
Deductions help bring down what you pay on your ordinary income. A taxpayer could choose between one of two deduction options.
Standard Deduction: A flat amount that can be deducted.
Itemized Deduction: A selection of deductions that apply to the individual, reported on Schedule A.
Now that you are aware of your two options let’s look at how those have changed with the new tax bill.
Standard Deduction Changes After The New Tax Bill:
Itemized Deduction Changes After The New Tax Bill:
These charts may be a bit confusing and take a moment to digest, but if you analyze these two comparisons, you will find that those who prefer the itemized deduction will feel a negative impact from the bill. On the positive side, this should only affect about 30% of taxpayers.
Change #2 – Personal Exemptions
Personal exemptions are deductions allowed for each dependent of the taxpayer. In 2017, you could deduct $4,050 for every dependent. Take a family of 4 for example. They could deduct $16,200 (4,050 x 4).
This deduction has been removed due to the standard deduction nearly doubling. The idea is that this switch will provide a bit of relief for those who do not utilize the personal exemption allowances. So while it benefits those who use the standard deduction, it does harm families with 5 or more members.
Families with 5 or more could have continued to deduct $4,050 for every additional dependent, before 2018. Some find this to be the biggest negative to the bill. In 2015, 82% of returns claimed to have dependent children at home. This means these are likely the individuals that will be affected by this change.
Change #3 – Child Tax Credit & Other Dependent Credit
As mentioned, there are a few ways to decrease how much you pay in taxes such as deductions and credits. The personal exemption deduction is no longer allowed, but the child tax credit can help make up for it. Similar to deductions the child tax credit can offer relief. This credit will be split between non-refundable and refundable amounts which are explained below.
This can lower how much you pay in taxes, but it cannot cause a refund.
This can lower how much you pay in taxes and potentially give you a refund. As of the new bill, only $400 of the total Child Tax Credit is refundable.
Now that you know how the credit works, it is essential to understand who can qualify as a dependent. In the following image, you will notice the changes in the amount of the tax credit, as well as the new rules listed.
If that seemed like a lot of tax talk, but the two main points you should get from this are qualifying children must be US Citizens, and the Child Tax Credit can help offset the negative impact from the loss of personal exemptions.
Change #4 – Updated Tax Rates
This change is pretty straightforward. The good news is most individuals will receive tax breaks. Unfortunately, this excludes those in the $400,000 – $416,000 range, they will have a slightly higher percentage.
Below, you will find the 2018 – 2017 Federal Tax Rate comparison. Which tax bracket do you fall under? Did the percentage go up or down?
Change #5 – Alternative Minimum Tax (AMT)
Wait, what is AMT?
AMT is a minimum the taxpayer must pay. It is usually reserved for high wealth individuals and determined via a specific calculation.
The AMT calculation is a bit complicated and does not apply to most taxpayers. The calculation includes items like personal exemptions and some various deductions that are no longer deductible. This results in even fewer taxpayers having to worry about AMT after 2018.
Change #6 – Kiddie Tax Rate
The Kiddie Tax Rate applies to children who receive unearned income over $2,100. Under the old rules, a child’s tax rate would equal that of their parents.
Under these new rules, children now have a separate tax rate. This is great for the kiddos because they are now much lower – time to open that lemonade stand!
Part 2 – What Does This Mean For Your Business?
When most people think of businesses, they think of big corporations like Amazon and Target – but you know different! As a business owner, you know that there are plenty of small businesses out there that classify as a Sole Proprietor, Partnership, LLC, or S-Corporation. The new tax bill keeps them in mind.
Consider these six big changes and how they could affect your business.
Change #1 – Flat Tax Rate
The flat corporate tax rate has dropped from 35% to 21%. Take those savings and build your business!
Change #2 – Employee Benefits
The following employee benefits were deductible for businesses before 2018, but are now excluded.
- Entertainment – This only includes entertainment, meals are still deductible. To learn more about this category of business expense visit our article here: Meals, Entertainment & Travel. What is Deductible?.
- Parking & Mass Transit Passes
- Transportation / Commuting
- Cycling Transportation
- Moving Expenses
- Lower Limits on Excessive Employee Compensation
- Lobbying Expenses
Change #3 – Depreciation
The changes to depreciation affect two specific sections and appear to be positive for business owners. For now, this is all you need to know since these changes are very detailed and complicated for those without a tax background. For that reason, we will move on and recommend if you have tangible personal property, consult with your CPA on how these changes can impact your business.
Change #4 – Section 199A Business Deduction
This is a complicated deduction that both excites and confuses some. What it ultimately comes down to is helping small businesses and sole proprietors by reducing their taxable income by up to 20%.
This deduction has a complicated formula that includes some exclusions and income limits. For this reason, we suggest you talk with your CPA to see how it may impact your business.
Change #5 – Partnership Technical Termination
Up to 2018, the rule was if 50% of a Partnership changed hands during the year, they would have to create an entirely new partnership.
Under the new tax bill, a partnership can continue despite changing hands during part of the year.
Change #6 – Estate & Gift Tax Exemption
The estate and gift tax exemption has now doubled for businesses.
This publication is designed to provide information of federal tax and accounting laws and/or regulations. It is presented with the understanding that the author is not rendering legal or accounting services.
This text is not intended to address every situation that arises or provide specific, strategic tax and/or accounting planning advice. This text should not be used solely to answer tax and/or accounting questions and you should consult additional sources of information, as needed, to determine the solution to tax and/or accounting questions.
This text has been prepared with due diligence. However, the possibility of mechanical or human error does exist and the author accepts no responsibility or liability regarding this material and its use. This text is not intended or written by the practitioner to be used and cannot be used by a taxpayer or tax return preparer, for the purpose of avoiding penalties that may be imposed.