With tax season looming, the rush for small business owners to complete their tax filing before the April 17 deadline is in full swing. And as if it wasn't already stressful enough, for the first time, SMBs will need to get to grips with changes to the way they file due to the Tax Cuts and Jobs Act, which came into effect on January 1, 2018.
The Tax Cuts and Jobs Act was intended to simplify much of the U.S. tax system and promised significant tax breaks for businesses of all sizes. With SMBs consistently citing taxes as one of their biggest problems, the bill appeared to quash many of their concerns.
A survey of National Federation of Small Business (NFIB) members revealed that 75% of small business owners believe the tax law will positively impact their business. As we enter tax season, SMBs will soon find out if this confidence in the reform was misplaced.
What are the main changes to business deductions?
Deductions underwent a major shakeup, and this is where small business owners may struggle to make sense of the impact the Tax Cuts and Jobs Act has had.
The tax reform was great news for small businesses structured as C corporations, as the tax rate was dropped from 35% to 21%. For everybody else, it was announced that a reduced tax rate would benefit small businesses in the form of the Qualified Business Income (QBI) Deduction (Section 199A). This gives a 20% deduction to pass-through entities and applies to businesses structured as a sole proprietorship, partnership, LLC, or S corporation.
However, as with most things tax-related, in reality, it is far from simple. As Lee Reams from TaxBuzz & CountingWorks explains: “The 20% deduction has a number of limitations and qualifications that make it difficult to understand by professionals - much less the average business owner. Most of these limitations are based upon the business owner’s personal 1040 taxable income not the business's taxable income. In addition, it applies one set of rules for specified service trades and businesses (SSTBs) and another for qualified trades businesses (QTBs).
“Tax reform singles out attorneys, accountants, performing artists, athletes, financial services, brokers (except real estate and insurance) and certain others as SSTBs. Once the SSTB owners 1040 taxable income exceeds $315,000 on a joint return ($157,500 for others) the deduction begins to phase out - and once it reaches $415,000 ($207,500) the deduction is phased out fully.”
Several deductions have been reduced or repealed, too. Transport expenses, entertainment expenses, and employee meal expenses have all been cut, or are no longer deductible at all. However, options for expensing and depreciating business assets have been modified, which is a good thing for small businesses looking to write off the cost of purchasing new equipment.
Are these changes going to make taxes even more taxing?
It’s not just deductions that have had an overhaul. Thought tax forms were going to be easier to complete? Think again. According to Vincent Porter, CPA:
“This year's tax returns will look nothing like tax returns that have been filed for the last 30 years. The typical 1040 is now revised to show only 23 lines compared the 78 on the old tax return. Gone are schedules A to F and replacing them are Schedules 1-6. The typical K1 now has a lot more information to report the needed information required for the new Section 199A 20% business deduction.”
Sounds complicated, right?
Start working with a tax preparer.
Some SMB owners do not find filing taxes a strenuous or stressful process. Before the changes, the right tax software made the process simple to complete without any assistance.
But that was then and this is now. With professional tax preparers having to work hard to educate themselves on the changes, small business owners are unlikely to be able to dedicate the time and resource they need to understand the new tax law.
For small businesses that haven’t considered working with a tax preparer before, choosing a reputable professional — especially during the busiest time of the year — can be challenging. While it’s tempting to go with the first person who has availability, incorrectly filing taxes can result in your business having to pay penalties to the IRS, so it's important to properly vet a tax preparer.
Here are a few things to look out for.
If a business owner is not familiar with tax terminology, working with a preparer who uses jargon isn’t going to be of any benefit. Businesses affected by the changes to deductions will need to understand how and why they have been applied so that they can be fully aware of what they can write off, helping them to plan finances for the year ahead. This is especially important for long term planning, as some of the tax changes are due to expire.
Don’t be Tempted to Scrimp
As part of the reform, expenses related to preparing and filing taxes (such as tax preparers or tax-preparation software) are now nondeductible. But seeking out the cheapest tax professional to make up for it is never going to be a good idea.
Legitimate tax preparers often charge by the hour. Businesses should be wary of tax preparers who base their fee on the size of your refund, or who advertise their services based on being able to guarantee a bigger refund.
Appearance isn’t Everything
Having a Preparer Tax Identification Number (PTIN) doesn’t automatically make a tax professional credible. Businesses should check that their chosen preparer is registered on the IRS directory and ensure that the qualifications they hold are from official bodies.
A reputable tax preparer should be willing to provide testimonials from their clients and should have no problem with a business owner conducting due diligence before hiring them by checking online reviews and ratings.
And if it All Goes Wrong...
Even the most experienced tax preparer has had to brush up on a lot of new legislation, and unfortunately, mistakes can be made, especially during the height of tax season. Because of this, a business owner should ensure that their tax preparer has errors and omissions insurance in case they do make a miscalculation. If they don’t, the business may find itself liable for paying fines to the IRS.
There is a lot for small business owners to consider when preparing for tax season. Whether they ultimately choose to do it alone, use tax software, or employ a tax professional, it's paramount that they invest time in understanding what the changes mean for their business, as the repercussions of not doing so could be costly.