What Every Business Owner Should Know
About the Upcoming Tax Changes
The Tax Cuts and Jobs Act of 2017 (“TCJA”) introduced several changes to the Internal Revenue Code, many of which favorably impact small business owners. However, a number of these rules are set to expire at the end of 2025.
This article will look at some of the key changes set to occur after the sunsetting date and how business owners should prepare for them, assuming Congress does not extend the TCJA provisions. That’s an important caveat, however: congressional action on at least some of these is likely. But the nature of that action will depend on what the President does, as well as the makeup of Congress.
The Potential Impact on Businesses
Corporate Tax Rate
The TCJA permanently reduced the highest corporate tax rate from 35% to 21%. This provision does not expire in 2025 when the other provisions are set to expire. However, we expect this to be a potential talking point during the 2024 election cycle and a focus of congressional activity in 2025, as a change in the corporate tax rate could impact the importance of the other provisions discussed below.
199A Qualified Business Income Deduction
When the TCJA reduced the corporate tax rate from 35% to 21%, it created a disparity for small business owners operating via pass-through entities such as S Corporations and partnerships. To add equity, Section 199A was introduced to allow a 20% deduction on Qualified Business Income (“QBI”), intending to bridge the gap between the individual tax rate and reduced corporate tax rate. As a result, business owners are able to potentially reduce their individual tax rate on QBI from 37% to as low as 29.6%. QBI is defined as certain types of business income in which the taxpayer “actively or materially” participates, with a variety of limitations. Thus, non-corporate taxpayers can benefit from active business activities conducted by S Corporations, Partnerships, LLCs and Sole Owner proprietorships.
The loss of this deduction would have a significant after-tax impact on business owners and the opportunity to grow their businesses and fairly compensate their service providers and employees.
Bonus Depreciation
TCJA altered the rules of bonus depreciation to include used property and allowed for 100% bonus depreciation deduction on qualified property. Generally speaking, this write-off is available for tangible depreciable property but also could apply to real estate improvements under certain circumstances. The bonus depreciation rules under the TCJA allowed for 100% write-off over the first few years, but is reduced to zero after at the end of 2026 as the provision sunsets.
An illustration of the bonus depreciation percentages is as follows:
Businesses considering capital improvements could benefit by making those investments prior to the sunset of bonus depreciation. Notably, however, a 2024 bill passed by the House of Representatives would have restored bonus depreciation in full for 2023-2025, so the issue is clearly top of mind for lawmakers.
The Impact on Wealthy Individuals
Estate and Gift Tax Planning
The TCJA increased the gift and estate tax basic exclusion from $5.5 million to $11.1 million for gifts and for decedents who died in 2018. The amount is adjusted for inflation each year, and the 2024 exclusion amount is $13.61 million per individual, and $27.22 million for married couples. At the end of 2025, this provision will sunset, resulting in the exclusion being reduced to about half of the current amount, adjusted for inflation.
Although there is time to plan for this reduced exclusion amount, most tax practitioners are advising their clients to begin taking steps in 2024 to maximize the use of the higher exclusions by beginning planning now, and potentially making transfers this year. Even if vehicles have already been created, funding them to the maximum beneficial amounts by the end of 2025 makes sense.
Individual Tax Rate
The maximum individual tax rate was reduced from 39.6% to 37% under the TCJA. This lower top individual tax rate is set to sunset and will revert back to 39.6% for tax years beginning after December 31, 2025.
State and Local Tax Deduction (SALT)
The TCJA capped state and local tax (SALT) deductions to $10,000, disproportionately impacting residents of higher tax states. Starting with tax years beginning after December 31, 2025, the limitation on SALT deductions is set to be lifted. This will allow taxpayers to fully deduct real estate taxes, state and/or local income taxes and personal property taxes being paid if they itemize their taxes on their personal tax returns.
However, taxpayers should be aware that the dreaded Alternative Minimum Tax, which was also limited by the TCJA, may kick back in after 2025, requiring them to determine the advantage or non-advantage of deducting SALT. The reversion could also remove the important of state pass-through entity taxes for small businesses, enacted as a work-around for the SALT limitation.
An Uncertain Future
There are many other variables to be considered in tax planning over the next few years in addition to the sunsetting TCJA provisions.
Further, since the sunsetting of the TCJA tax provisions would require legislative action, one has to wonder whether Congress will be able to agree on any replacement provisions. A failure to do so would leave taxpayers and tax practitioners alike in a state of paralysis. The House of Representatives passed a significant tax bill with bipartisan and presidential support earlier this year, but the measure has stalled in the Senate. So, while the likelihood of congressional action is higher than normal, businesses still need to be prepared for what will happen without it.
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The information presented here should not be construed as legal, tax, accounting, or valuation advice. No one should act on such information without appropriate professional advice and after a thorough examination of the particular situation.