Tax Reform and Planning Considerations for Small and Medium-Sized Businesses
The recently enacted tax reform act has businesses and tax professionals scrambling to make sense of it all. Small and medium-sized businesses (SMBs), in particular, are working to understand the changes. As introduced by Congress, the changes are purported to be good for SMBs. However, experts are not yet clear as to what degree the changes will have a positive impact. This will depend on the specifics as rolled out in the interpretations and regulations. Now is the time for business owners to consider how these new changes will impact their bottom line and how to best plan for the future.
The new tax laws allow more small business owners to take advantage of accelerated depreciation. The Section 179 Deduction has been expanded – the deduction increased to $1 million, and more property will now be eligible for the deduction, including HVAC equipment and security systems that were previously ineligible. First-Year Bonus Depreciation has also been expanded. The 100% deduction (increased from 50%) is allowed for qualifying property, which now includes used property, through the year 2022, and it will fully phase out in year 2026. SMBs considering expansion may want to take advantage of these deductions before these provisions sunset.
R&D Tax Credit
The Research and Development (R&D) Tax Credit itself has not changed much, but more businesses will be able to utilize the credit under the new tax law Although the R&D Credit was made permanent prior to tax reform, many SMBs were effectively barred from utilizing the R&D Credit because of AMT limitations. Under tax reform, AMT has been repealed at the corporate level and therefore, the R&D Credit will no longer be limited by AMT. As a result of these changes, more small businesses (including many startups) will be able to utilize the R&D Credit, and reap the benefits into the future.
Cash Method of Accounting
Under the new tax reform, more SMBs will have the option to use the cash method of accounting. Under previous law, C corporations and partnerships with corporate partners were only eligible to use the cash method if their three-year average annual gross receipts was less than $5 million, but the new law raises this limit to $25 million. While the cash method of accounting may not be the best option for all small businesses, having it available to them will allow for more diverse planning opportunities.
Accounting for Inventory
Accounting for inventory can be burdensome for small businesses, and luckily, the new tax law allows more SMBs flexibility in this area. Previously, businesses whose three-year average annual gross receipts exceeded $1 million were required to account for inventory under certain prescribed methods, such as the full absorption method or the retail method. Now, SMBs can treat their inventory as non-incidental materials and supplies, as long as their three-year average annual gross receipts does not exceed $25 million. This change simplifies the accounting requirements for many SMBs.
With all of these changes, SMBs may want to consider whether their chosen entity selection will continue to serve them well into the future. For decades, flow-through entities like S corporations and partnerships were seen as the preferred option for SMBs, as they provided simpler administration, eliminated double taxation, and allowed for quicker earnings distributions. The new tax law may change this assumption. The new tax law entices corporate ownership by lowering corporate tax rate to 21%, whereas flow-through taxation taxes earnings at the individual’s rates, which are much higher. While the 20% Qualified Business Income Deduction is available for some flow-through business owners, it is disallowed for many high-earners and businesses in certain industries. Additionally, even though the threat of AMT has certainly lessened for individuals, the corporate AMT has been eliminated completely, and that is difficult to beat. Ultimately, the choice of entity type should be made by carefully considering the historic and projected operating elements of the business, distribution strategies, and the objectives of ownership. Now is a time when SMBs should reevaluate their chosen entity structure to ensure they have made the best choice.
To discuss these changes and additional planning strategies for your SMB, contact your WNDE tax professional.