Ah tax reform. Gotta love it. A new President comes to town and has to radically change something, so why not change an already confusing area of every American's fiduciary duty to their country.
Some will gain, and some will lose. It seems like this happens every time a new President comes into office, so let's jump right in and learn about the inevitable.
I will be referring to all Sole Proprietorships, Partnerships, and S Corporation as "Flow-Through Entities" from here on out.
My takeaways from the Senate and House GOP tax reform bills:
1. Owners of flow-through entities will be taxed on their earnings at a maximum of 25%.
2. Both bills, as is, would permanently cut the corporate tax rate to 20% from 35%.
3. There are numerous deductions that many us of benefit from that are being limited or
eliminated completely.
If you're an owner/partner of a flow-through entity, you may think "Wow, this is great! Having my earnings taxed at 25% will save me a bunch of money!!"
Think again. The vast majority of small business owners are already in that 25% tax bracket individually. So this change really won't help as much as you would think. This part of the reform will primarily help those wealthy individuals in the 35% or 39.6% tax brackets. Now the income they receive from these flow-through entities will be taxed at a much lower rate than their current tax bracket. So if you're lucky enough to be in these higher tax brackets, feel free to jump for joy!
Both versions of the bill would permanently cut the corporate tax rate from 35% to 20%. As great as this sounds, speculators are saying this part of the reform will be temporary at best. If this part of the bill does pass, you may want to talk to your CPA about the advantages/disadvantages about forming a C Corporation.
Radical changes have been made in the form of repealing or limiting certain tax deductions.
Having a family just got more beneficial. Proposals in the new tax bill outline for a $600 increase in the child tax credit from $1,000 to $1,600. An additional $300 credit will be given to each parent as part of a consolidated family tax credit.
Along these same lines of encouraging families to grow and stay together, the amount of alimony paid will no longer be an allowable deduction. Better think twice about getting a divorce!
The House bill writers call for home interest deductions for newly purchased homes being capped for mortgages valued at $500,000 instead of the current $1M for married couples. The real estate market today is making it harder and harder to find homes less than $500,000. Especially in pricey cities such as San Francisco or Boulder. The local property tax deduction will also be capped at $10,000. My 2,000 square foot townhouse in Dallas has more than half of that in property taxes every year. Imagine living in a larger home in a happening real estate market. I'm sure property taxes are out the roof! Pun intended.
Not only will this hurt people wanting to buy expensive property in the future, but it will significantly limit the income of real estate agents in those markets.
So if you plan on buying an expensive home, do it now to lock in the existing tax deduction amount and help out a fellow real estate agent.
The reason the tax reform bill is changing the treatment of the most popular itemized deductions is to simplify the tax filing process and encourage people to use the, now higher, standard deduction. The standard deduction amount for single filers and those filing jointly will nearly double under both the Senate and House bills.
Have student loans? You might not receive that "glorious" tax deduction you once enjoyed.
The bill outlines removing the student loan interest deduction, so continuing your education may come back and bite you in the bum even more than it already did. On the bright side, this part of the reform may encourage more and more people to become entrepreneurs. Come join the New Rich!
Now that both the House and the Senate have released their versions of the tax bill, they will soon duke it out early next week to see who's policies will make it to the final product. With that being said, be on the lookout for an updated article as there will undoubtedly be numerous changes to the proposed bill.
Thanks for reading this discussion of what every entrepreneur needs to know about the tax reform bill. If you benefited from this article, please comment and share with your friends and co-workers!
Here's to making money and KEEPING that money,
AZ