provided a 20 percent deduction for those businesses. So, for example, if your sole proprietorship netted you $65,000 in 2022 as a single taxpayer, that would push you into the 22 percent federal income tax bracket. But you get to deduct 20 percent of that $65,000 of income (or $13,000) for the pass-through deduction so you would only owe federal income tax on the remaining $52,000 ($65,000 – $13,000).
Another way to look at this is that the business would only pay taxes on 80 percent of its profits and would be in the 22 percent federal income tax bracket. This deduction effectively reduces the 22 percent tax bracket to 17.6 percent.
This is a major change that not surprisingly has made small business owners exceedingly optimistic about being able to grow their businesses. In fact, in a survey of small business owners conducted by the nonprofit National Federation of Independent Business just after the tax bill was passed and signed into law, a record percentage of those surveyed (covering the survey’s 45-year history) expressed optimism about it being a good time to expand their businesses.
This 20 percent pass-through deduction gets phased out for service business owners (such as lawyers, doctors, real estate agents, consultants, and so on) at single taxpayer incomes above $170,050 (up to $220,050) and for married couples filing jointly incomes that exceed $340,100 (up to $440,100). For other types of businesses above these income thresholds (for tax year 2022), this deduction may be limited so consult with your tax advisor.
Enjoying better equipment expensing rules
Through so-called section 179 rules, small businesses have historically been able to immediately deduct the cost of equipment, subject to annual limits, they purchase for use and place into service in their business. But the Tax Cut and Jobs Act bill expanded these rules.
Now, more businesses can immediately deduct up to one million dollars in such equipment expense annually (up to the limit of their annual business income). And, this deduction can also now be used for purchases on used equipment. These provisions, which don’t apply to real estate businesses, remain in effect through 2022 and then gradually phase out until 2027 when the prior depreciation schedules are supposed to kick back in.
Increasing maximum depreciation deduction for automobiles
The new tax bill included a major increase in the maximum amount of auto depreciation that can be claimed. The annual amounts of auto depreciation have more than tripled. Effective with tax year 2022, the maximum amounts that can be claimed are as follows:
Year 1: $10,000 up from the prior limit of $3,160
Year 2: $16,000 up from the prior limit of $5,100
Year 3: $9,600 up from the prior limit of $3,050
Year 4 and beyond: $5,760 up from the prior limit of $1,875, until costs are fully recovered
These limits increase annually with inflation.
Limiting interest deductions
Effective with 2018, companies with annual gross receipts of at least $25 million on average over the prior three years are limited in their deduction of interest from business debt. Net interest costs are capped at 30 percent of the business’s earnings before interest, taxes, depreciation, and amortization (EBITDA). Farmers and most real estate companies are exempt.
Effective in 2022, this provision actually gets more restrictive and would thus effect even more businesses. At that point, the 30 percent limit will apply to earnings before interest and taxes.
Reducing meal and entertainment deductions
The tax reform bill of 2017 eliminated the entertainment expense deduction for businesses. Under prior tax law, 50 percent of those expenses was deductible, for example, when a business entertained customers and even employees at sporting events, fitness clubs, and restaurants.
The new rules do include some exceptions. On-site cafeterias at a company’s offices and meals provided to employees as well as business meals associated with travel are 50 percent deductible. Meals provided to prospective customers as part of a seminar presentation are still fully deductible. Holiday parties and company picnics are also fully deductible as long as they are inclusive of everyone.
Eliminating the health insurance mandate
Since the Affordable Care Act (also known as Obamacare) was passed by Congress in 2010, some Republicans in Congress vowed to repeal it. With the election of Republican Donald Trump in 2016, it seemed that the pieces were in place for Obamacare’s successful repeal. But, Republicans fell one vote short in the Senate when the late Arizona Senator John McCain gave the repeal measure his infamous thumbs-down vote.
So, the 2017 tax bill included a little known or discussed measure that eliminated Obamacare’s mandate effective in 2019, which required people to have or buy health insurance coverage and if they didn’t, they’d face a tax penalty. So, the penalty tax also disappeared in 2019.
Revising rules for using net operating losses
Net operating losses (NOLs) can no longer be carried back for two years. However, NOLs may now be carried forward indefinitely until they are used up. Previously the carryforward limit was 20 years (the CARES Act allowed 2018–2020 NOLs to be carried back five years).
NOLs are limited each year to 80 percent of taxable income.
Considering the SECURE ACT of 2019 and COViD-19 Relief Tax Acts
A number of smaller tax-related bills passed in recent years made some changes that affect small businesses. These bills include the SECURE (Setting Every Community Up for Retirement Enhancement) ACT of 2019 as well as the COVID-19 relief bills. Here are the highlights of the SECURE Act that small business owners should be aware of:
Small-business owners are eligible for up to $5,000 in tax credits when starting a retirement plan. This credit applies to new 401(k), profit sharing, SEP, and SIMPLE plans for small employers with up to 100 employees.
More part-time workers can participate in company 401(k) plans. Previously, employees had to work at least 1,000 hours per year to take part in a company’s 401(k) plan. Now, workers who achieve at least 500 hours over three consecutive years may participate.
You can withdraw up to $5,000 per parent penalty-free from your retirement plan for a “qualified birth or adoption distribution” for the birth or adoption of a child. This new provision waives the normal 10 percent early withdrawal penalty and allows you to repay the withdrawn money as a rollover contribution.
Required minimum distributions (RMDs) from retirement accounts begin at age 72, not 70½. This gives you more options and flexibility, but delaying required distributions which are based upon your life expectancy may or may not be in your best long-term interests. It’s impossible to know for sure, but you and/or your tax advisor may want to crunch some numbers, which requires making some assumptions, to see what the optimal age is to begin your RMDs.
You can make traditional IRA contributions past age 70½ so long as you continue earning employment income. This will bring the contribution rules for these accounts into alignment with those for Roth IRAs and 401(k)s.
Contemplating Potential