Written by Edward Smith
As Congress rushes out new legislation before the end of the year that will impact on multiple levels how everyone does business, it’s important to understand a few key concepts.
In order to make typically larger C-corporations more competitive globally, the House and Senate negotiated the corporate tax rate down to 21 percent.
But many representatives also wanted to include breaks for small businesses into the tax plan, and in order to get the votes necessary to pass, the reconciled bill decided to use a deduction on pass-through income in hopes that a smaller tax burden would result in reinvestment.
Where C-corporations are taxed as an individual entity, the profits S-corporations pass onto their shareholders are taxed as personal income.
Additionally, most small-business owners in LLPs, sole-proprietorships and partnerships elect to declare their profits as personal income. This is known as pass-through income.
In the early 1980s, business income from C-corporations accounted for almost all business income, according to a May article from the Brookings Institute. It was in 1986 that the shift began and it became more profitable for corporations to restructure, oftentimes as S-corporations or partnerships.
What the bills appear to do is change the way the tax is structured.
“The House bill will tax you by moving the rates around, the Senate wants to take a deduction,” said Kevin Green, CPA at M. Green and Company, LLP, in Tulare.
The final bill is a 20-percent deduction on pass-through income from out of the Senate bill.
Something like a deduction has never been done before, according to Kevin Green, CPA at M. Green and Company, LLP in Tulare. Its affect on business would only be theoretical.
What it appears to mean is that if a business were to make $100,000, the Senate bill would deduct 20 percent of that and tax a company on the remainder.
“It’s conceptual at this point,” said Green. “They’re just trying to figure out a way to give those flow-through people a tax benefit like they gave the corporations a tax benefit.”
Both Green and Vera agree that the overall effect the bill haves on small business will depend on its size.
As it stands, Vera thinks most of the benefits will be felt for businesses above $260,000.
“[This] is good compared to what they are paying now, but it’s not the 20 percent that C-corporations are getting,” Vera at Fresno State said. “The tax reform is biased toward larger institutions. They are trying to pass benefits across the board, but this is a balancing act. You have to make sure there is income generation.”
The hope is that more cash-on-hand for business means more money for things like wages, hiring and capital formation.
For those in the business world, including Mike Betts, CEO of Betts Manufacturing, tax reform is something he’s been waiting for.
“Wages have climbed back up and health care has gone up and workers’ comp has gone up,” said Betts, who is also chairman of the San Joaquin Valley Manufacturing Alliance. “For a manufacturer to get some recovery, being able to pay less taxes will allow them to reinvest in their business in numerous ways that will ultimately benefit their company.”
Though analysts are skeptical of the exact degree that the pass-through rate would have on the overall economy, business owners hope to get what they can.
“Manufacturers have to reinvest every year,” Betts said. “You have to reinvest to stay relevant and stay current or you’ll go backwards. We’re very capital intensive. To be able to have that additional income to reinvest is absolutely huge.”
Provisions in the new law now make that kind of reinvestment easier on the bottom line.
Before, section 179 of the tax code limited deductions business owners could take on big-ticket purchases on things like equipment for manufacturers to 50 percent of their value and only on new items.
The new deduction, called the bonus depreciation provision, allows for business owners to deduct 100 percent of the value of equipment purchases up-front for the next five years, on both new and used items, which in Green’s eyes is huge for business.
“The intent here is to have aggressive tax deduction to motivate business to build or improve their plant and equipment,” Green said. “That’s good for the tractor guys, the guys providing equipment to the plant.”
The ability to reinvest is what legislators are hoping will make up for the predicted $1.8 trillion hit the debt will take over the next 10 years.
“For every manufacturing job, there’s somewhere between 3-6 more jobs generated in the community where the manufacturer resides because of all the support they need from the supply side,” Betts said.
One of the other goals of the tax bill was to reduce complexity.
“If you ask — across the spectrum in the economic or the political arena — people are going to tell you the tax code is too complex,” Vera said. “Streamlining the process creates efficiency.”
One of the biggest culprits creating headaches for business is the alternative minimum tax, which was put into place to ensure that businesses are paying at least a baseline amount.
What the bill now does is eliminate the corporate AMT and increase the individual threshold to $70,000, according to an article in CNN Money.
Green feels that eliminating the AMT would generally be a good thing for small business. Not only would businesses avoid paying the additional fee calculated into the AMT, but it may simplify the tax code in that a lot of mid-size business owners that have had to file the AMT before may no longer have to calculate their taxes twice.
“Many small businesses, as their income gets higher, they get subject to this alternative minimum tax,” Green said. “It’s a parallel tax system. You figure your regular taxes and you figure your alternative minimum taxes and whichever is higher is the one you pay.
Most analysts are looking to what’s in the Senate bill, considering the far-smaller margin of votes and at this point, the Senate has decided to keep the AMT, according to a Dec. 1 article in the Wall Street Journal.
But lower taxes might make the AMT irrelevant.
“If you bring down the tax to 20 percent, which is the same as the alternative minimum tax, that will technically be taking it out of the picture,” Vera said.
Regardless of how this tax bill ends up, business owners need to consult their tax specialists before the new normal rolls out.