This article was originally posted here, co-authored by Andrew McCormac (EGFS) and Doug Bend (Bend Law Group).
On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act of 2017 into law. The Act was the biggest change in tax laws in more than 30 years and brought about many changes for individuals and companies. Overall, we believe that the changes will benefit new businesses by lowering tax rates, accelerating the depreciation of equipment and eliminating the corporate alternative minimum tax. Here are the top seven ways the new tax law could affect your startup:
1. Lower Taxes for C-Corporations: Most startups that are looking to raise third-party capital to grow are C-corporations. Under the new tax law, the corporate tax rate will drop from 35% to 21% starting this year (See Section 13001 of the act). Clearly, income-producing corporations will retain more profits. For startups, which generally do not generate profits in the early years of the business, this change will likely be minimal but still beneficial.
2. Lower Taxes for Certain S-Corporations and LLCs: Startups that are S-Corporations or LLCs might qualify for the 20% deduction on the income attributable to that entity as long as the business or service isn’t listed on the exclusions. Excluded businesses and services include consulting, health, law, athletics, financial services, brokerage services industries or businesses where the principal asset is the reputation of the employees. Excluded business can still take the 20% deduction if their taxable income is less than the threshold amount — $157,500 for single filers and $315,000 for joint filers. The deduction is fully phased out when income exceeds $207,500 for single filers and $415,000 for joint filers for 2018 tax years. In addition, the 20% deduction is phased out if you have W-2 income above $157,500 or $315,000 for joint filers. Thus, excluded businesses owners cannot increase their wages to decrease the S-Corporation income to circumvent the threshold amounts. Nor can you have wage income from other sources that exceed the threshold and still avail yourself of the deduction.
3. Accelerated Depreciation of Equipment:Previously, startups had to depreciate the cost of equipment over the asset’s useful life. Under the new tax law, 1 million in equipment can be fully deducted in the year it is purchased. This means you generally can expense twice the amount in 2018 through 2022 than what you did in 2017. If you have substantial fixed asset cost and current tax liabilities, this benefit provides significant tax savings. After 2022, the increased expensing phases out.
4. Elimination of Entertainment and Transportation Expense Deductions:Entertainment expenses, such are sporting events, are no longer deductible. Although business meals remain 50% deductible, employer-provided eating facilities are now subject to the limitation. Expenses for employer-provided transportation benefits, such as mass transit passes or providing transportation (related to commuting to/from your residence to work) are disallowed. You should note that the bicycling commuting reimbursements exclusion is suspended under Section 11047 of the Act.
5. Elimination of Corporate AMT: The alternative minimum tax was eliminated from corporate taxation. (The individual component was drastically raised.) Previously, many unwary entrepreneurs were subjected to the AMT by exercising incentive stock options (ISO) resulting in unrealized gains. Unrealized ISO gains and state income taxes among other items are “preference items” or additions to taxable income under the AMT system. Going forward, the act raises the exemption amount by almost 30%, which will allow more entrepreneurs to escape the AMT trap.
6. Repatriation of Overseas Profits:Repatriated profits will be taxed at 8% for non-cash assets and 15.5% for cash. This is a deemed repatriation so you are taxed regardless of whether you actually repatriate the funds. In addition, most companies will need to record income tax expense for profits, which were permanently deferred historically.
7. Legal Entity Choice: Despite all these changes, it’s just as important to recognize what will likely stay the same. Most startups that plan to raise third-party capital are likely to continue to be Delaware C-Corporations as venture capitalists haven’t indicated that they’ll no longer prefer to invest in Delaware C-Corporations. While the Tax Cuts and Jobs Act of 2017 will increase the tax liability for some individuals, overall the law will benefit most startups.
The information provided here is not tax or legal advice and does not purport to be a substitute for advice of counsel on any specific matter. For tax and legal advice, you should consult with your accountant or an attorney concerning your specific situation.
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