As the first quarter of 2018 winds down, many business owners find themselves still trying to make sense of tax laws that Congress passed at the end of 2017. These new rules mainly affect small businesses and pass-through entities. Before we discuss the specific changes, it’s important to understand each type of business structure. They include:
Sole Proprietorship: Self-employed individuals with no employees report their business income and expenses on their personal tax form, which is Schedule C of form 1040.
Partnership: This business entity allows two or more people to form a general or limited partnership. The company files a separate tax return with form 1065. Business income and losses pass through the partners who must report that information on their personal income tax return as well.
Limited Liability Corporation (LLC): Business people under this tax entity can choose to be taxed as a corporation or partnership.
LLC with a single member: This business professional reports his or her income on a form 1040, the same as a sole proprietor.
Personal Service or Professional Corporation: The Internal Revenue Service (IRS) typically reserves this classification for doctors, lawyers, architects, and similar professions.
S Corporation: Operators of an S Corporation file form 1120-S for their federal return. This entity passes most business income or loss through to the shareholders who must report the information on their individual returns with the IRS.
C Corporation: This business entity files form 1120 and must remit any taxes due. Shareholders of the company pay tax on dividends received at their individual tax rates.
The Biggest Corporate Tax Changes for 2018
Before January 1 of this year, corporations paid federal taxes that ranged from 15 to 39 percent. This was similar to individual tax rates that ranged from 10 to 39.6 percent. Under the new tax law, corporations pay a flat tax rate of 21 percent. The challenge with this new law is that pass-through scenarios don’t work when the IRS assesses lower tax rates to companies than to individuals. However, it would defeat the purpose of the pass-through for entities if the government creates a different tax rate.
The way that Congress decided to solve this dilemma was to tax business owners at an individual rate along with a 20 percent deduction to reduce the overall rate. This applies only to businesses where income passes through to a single person from a pass-through entity and that person earned the income while in business as a sole proprietor.
Unfortunately, this is far more complex than it sounds. For starters, income limits apply. Individual taxpayers can’t earn more than $157,500 and married taxpayers can’t earn more than $315,000. Qualified business income, qualified property, and special service trade or business rules apply as well.
We’re Here to Help You Make Sense of It
At Palmetto Payroll, it’s our job to keep up with changes to tax law and ensure that our clients take advantage of strategies that will leave them with the lowest possible liability. Please contact us to learn more about these and other tax law changes for 2018.