I had the great fortune to have attended a Jesuit high school and a Jesuit college. Central to that unique education was the belief that we should delay having an opinion about anything until we carefully study it and consider its issues, pray for understanding and insight, and then form an educated opinion but remain open to the possibilities of more insight.
I have tried to carry that belief through my life and as a tax lawyer have found great benefit from that teaching.
The new federal tax law is very complicated and impacts many of us in a variety of different ways. In an effort to help all of my readers have educated opinions about its impact, I have engaged in a four-part non-political description of some of its broader provisions.
I hope you find them helpful.
Today is the third installment. We are going to talk about some of the business incentives that may, in my view, save taxes and provide an impetus to our economy:
- New 20% Deduction for Businesses
I think this is one of the most important provisions in the new tax law.
As you know, income from certain types of business entities passes through to the owners and is taxed on their personal returns at their personal tax rates. The most common examples of this are Sole proprietorships, S corporations, Partnerships, and some LLCs. At the end of the year owners receive a Form K-1 that contains the income from that business and they report that business income on their personal tax returns.
The new tax law provides a new and unprecedented deduction to these small business owners. It allows them to deduct 20% of their “qualified business income” from the taxable income on their personal tax returns. Now this does not affect their claiming the new standard deduction that was doubled in amount.
This new deduction is limited for high income individuals and is also limited for businesses that have certain exempt passive type income.
Much of the press has been reporting that the new tax code provisions benefit the wealthy and the big corporations. Whether or not you think that is true, it is certainly NOT true as to these two key provisions.
The reality is doubling the standard deduction benefits those who have limited income and therefore don’t itemize. Likewise, this large 20% deduction affects mostly small business owners, is not applicable to large C corporations, and is limited or phased out as to the wealthy owners who have significant income or are receiving passive type investment income.
A word of warning. This provision is very complicated. You need to carefully plan for it and make the proper estimated tax deposits.
- Limitation on Losses
In the past, a large company could generate a tax refund when it expanded or started another business. It would do this by incurring large startup costs and write off large first year depreciation expenses. These startup losses could be carried back against income in prior years and generate a tax refund-cash. This worked for larger businesses that had significant income in prior years. It didn’t work for new small businesses that had little or no prior year income and were often undercapitalized and had to close because of the startup losses.
The new tax law eliminated the carryback of losses by these large businesses and thus eliminated the carryback tax refunds. Further, while the losses may still be carried forward, the amount deductible is now limited.
Whether you support this provision or not, it clearly reduces a tax benefit primarily used by larger businesses.
- New Limits on Excessive Compensation
Presently a publicly traded corporation cannot deduct salaries that exceed $1 million. These large corporations have avoided this rule by paying commissions, stock options, large retirement plan contributions, etc.
The new tax law limits some of these exceptions.
So folks, here’s the deal. Keep an open mind when you hear some of the press claim the new law is a giveaway to large corporations. Many of its provisions are just the opposite.
David Leeper is a Board Certified federal tax attorney with 38 years of experience. He can be reached at 915-581-8748, by email at firstname.lastname@example.org, or visit leepertaxlaw.com