A lot has been written on the new tax law, more formally known as the Tax Cuts and Jobs Act (TCJA), and how it will affect taxpayers. But really, what most business owners want to know is the bottom line – the actual numbers – and how the TCJA will affect them personally.
There is really no simple way to determine how the tax law will affect you without a comprehensive analysis of your tax situation. (No worries – we can do that for you! Contact us to talk with one of our tax experts.)
We’re going to show you the numbers through a real life example. Let’s take a look behind the curtain, shall we?
Business Owners Have Important Decisions to Make
If you’re a business owner, and not just an individual taxpayer, the TCJA requires you to make some critical decisions in the near future. Let’s look at choice of entity.
For instance, it might be advantageous for an S corporation to change to a C corporation. Also, and this is really important, if the entity is something other than a C corp, you will need to determine if you’ll be eligible for the 20% Qualified Business Income deduction.
As with most business decisions, it’s a smart idea to have a CPA do a thorough analysis of your specific situation in order to choose the best entity type.
A Comparison of Tax Liability: Before and After the New Tax Law
The best way to illustrate how the new tax law will affect business owners is to look at a real-life situation that shows a business owner’s tax liability both before the tax law (2017) and after the tax law (2018).
Let’s set the scene. Alice is the owner of Big Dogs Drywall, a small construction company. The business is an S corp. Alice is the sole owner, married with two children, and takes an annual distribution of $300,000.
The following table shows Alice’s tax liability for both 2017 and 2018, with 2018 reflecting the new tax law’s changes.
Tax Liability Before and After the New Tax Law
| 2017 | 2018 | |
| INCOME | ||
| Wages | $ 100,000 | $ 100,000 |
| Interest and ordinary dividends | 10,000 | 10,000 |
| Qualified dividends | 10,000 | 10,000 |
| Long term capital gains (LTCG) | 5,000 | 5,000 |
| S corp income | 350,000 | 350,000 |
| Total income | 475,000 | 475,000 |
| ABOVE THE LINE DEDUCTION | ||
| Domestic Production Activity deduction | (31,500) | - |
| Adjusted gross income (AGI) | 443,500 | 475,000 |
| ITEMIZED DEDUCTION | ||
| Income taxes | (25,000) | (10,000) |
| Real estate taxes | (10,000) | - |
| Mortgage | (15,000) | (15,000) |
| Charity | (10,000) | (10,000) |
| Miscellaneous above the 2% | (5,000) | - |
| Income limitation | 3,891 | - |
| Total itemized deduction | (61,109) | (35,000) |
| No exemptions (2017 income to high, 2018 no longer exists) | - | - |
| Qualified Business Income deduction (new for 2018) | - | (70,000) |
| Taxable income | 382,391 | 370,000 |
| Tax | 98,706 | 78,979 |
| AMT | 7,140 | - |
| Total tax (excluding NIIT) | 105,846 | 78,979 |
| Child tax credit | - | (250) |
| Total tax due | $ 105,846 | $ 78,729 |
As you can see, Alice’s tax bill is lower in 2018 compared to 2017, by $27,117, under the new tax law. The reason for the decrease is mainly due to the Qualified Business Income deduction and lower tax rates. When doing your tax planning, it is absolutely critical that you make sure your business qualifies for the full 20% deduction.
Now let’s consider this same scenario, but with Alice’s business changing from an S Corp to a C Corp as of January 1, 2018.
| C Corp After New Tax Law | |
| 2018 | |
| C corp net income | $ 350,000 |
| 21% flat tax rate | 21% |
| $ 73,500 | |
| Dividends paid | $ 300,000 |
| Qualified dividends tax rate | 15% |
| Taxes paid on shareholder's 1040 | $ 45,000 |
With Alice’s business as a C Corp instead of an S Corp in 2018, her tax bill is slightly lower. However, she will need to factor in the dividends paid out, as that amount will be taxed at 15%. That number could be higher or lower depending on an individual’s taxable income. In this scenario, it would not make sense to convert the business to a C Corp.
For most small businesses where the owners take distributions/dividends, an S Corp will most likely be more advantageous. Even for large corporations, which might not need to declare dividends, there are still other factors to consider.
More Money In Your Employees’ Pockets?
Most taxpayers have seen increases in their paychecks as employers decreased their withholding due to the anticipation of a tax decrease. However, based on a report from the Government Accountability Office, 30 million taxpayers – that’s roughly 21% of all taxpayers – will have under withheld and will owe money comes April 2019. Even if you believe your tax situation is relatively simple, regardless of whether you are a business owner, it is wise to run a tax projection to avoid unpleasant surprises.
What Will the Future Look Like for You?
Many taxpayers, particularly business owners, are unclear on what their tax situation will look like in the future. For a broad overview of the tax law, check out our blog post, Here’s How the New Tax Reform Law Will Affect You and Your Business.
Contact us online or call 800.899.4623 to speak with one of our tax advisors, who will explain how you can prepare for the future, and take advantage of any new tax savings opportunities.
