Many small and medium-sized companies are about to get hit with a new series of brutal financial shocks starting this year as key elements of the Trump-era Tax Cuts and Jobs Act of 2017 start to expire.
Having been written into law a half-dozen years ago, the “sunsetting” of the tax provisions in question shouldn’t be a surprise. But many business owners seem to be in the dark about the scheduled changes, or at least the blow they could represent for their current and future prospects.
It’s hard to overestimate the magnitude of the 2017 bill. And with one notable exception—a cut in the top rate for the “C Corp” tax rate, from 28% to 21%—everything in it is being phased out, with the first provisions ending this year.
Here’s how the guts of the law are scheduled to come undone:
• For this year: “Bonus depreciation,” the accelerated deducting of the purchase price of certain assets, was 100% for the past five years. This year, it drops to 80%, with further annual declines of 20% drop until it’s gone entirely.
• The qualified business deduction, also called the section 199A deduction, allows many “flow-through” business owners to reduce their taxable net income up to 20%, with savings commonly amounting to several thousand dollars. And it’s simply going away in 2025. But the loss of this deduction won’t just mean a 20% tax hike, because the top marginal rate will jump back up to 39.6%, compounded by reversion to the previous bracket structure which will see many being hit with a higher tax rate on lower incomes. Even the standard deduction is being cut by more than half. Those changes together add up to a dramatic tax hit for small business owners.
• Estate taxes will also kick in at much lower estate sizes than is currently the case, requiring business owners to scramble to do significant estate planning – which can also tie up cash and flexibility their businesses often need for growth.
The result of all this is not going to just be business owners feeling a bit less prosperous. Many small and medium-sized enterprises currently don’t have sufficient working capital for growing their businesses, or for any more unexpected expenditures or emergencies. And with banks and credit markets retrenching after notable bank failures and increasing interest rates, it’s not getting better any time soon.
Those hoping that the two parties in Washington will come together to help independent business by extending a tax bill seen as helping “the rich” have probably not been closely following the news. So it appears it’s up to business owners to face this unpleasant but inevitable situation head-on, and as soon as possible.
• Any firms that can take advantage of the bonus depreciation component of the 2017 law, should. In 2023, you still get to deduct 80% of the total price of certain capital goods in the first year. So if you were planning to add an assembly line or any other sort of equipment, upgrades, additions or expansions, now is the time to utilize this valuable tool.
• Now is also the time for anyone who has benefited from Qualified Business Income deduction to determine if they have any carryovers which may expire and could be unlocked as well as identify ways to accelerate income into years where “QBI” is still available, maximizing the benefit of this provision. Paying tax on 80% of your income is better than paying tax on 100% of your income.
Overall, however, the looming changes suggest something more ominous than the sum of its provisions. The unceremonious expiration of the Tax Cuts and Jobs Act indicates a sea change in how independent business is taxed. Like it or hate it, in the coming years D.C. is going to need to be raising as much revenue as it can, and independent business doesn’t have much pull in Washington.
So we should expect to see a rising tax burden placed on small businesses and their operators, regardless of the other stresses they face. We can also expect to see the 87,000 new IRS agents we’ve been reading about to be focused disproportionately on this same group of taxpayers.
The good news is that small businesses frequently overpay taxes, with surveys indicating more than 90% of small businesses routinely miss areas of tax savings. That figure is likely to increase as the key provisions of the Tax Cuts and Jobs Act are wound down. That creates a big imperative for business owners to pause and take a closer look into their taxes and engage in tax planning, and not treat a grim fiscal inevitability like another unfortunate surprise.