While we’re still in the speculation stage as to what the final tax reform bill will look like, the various proposals put forth by President Trump and the House indicate that tax relief for small businesses could well be on its way.
President Trump’s and the House’s proposals are seeking to lower the maximum tax rate on C-corporations to 15 and 20 percent, respectively, from the current top rate of 35%. Both plans do away with the alternative minimum tax (AMT) for corporations. Also, both President Trump and the House propose eliminating or modifying nearly all of the special-interest deductions and credits like the domestic production deduction and the research and development credit, in lieu of the lower proposed tax rates.
Another significant change outlined in both President Trump’s and the House’s proposal is the switch to a territorial tax system from our current worldwide tax system. Under the territorial tax system, U.S. companies would no longer be subjected to taxation on their worldwide income; instead businesses would only be taxed on income within our country’s borders.
Most American small businesses are set-up as pass-through entities, such as S-corporations, limited liability corporations (LLCs), and partnerships. These types of companies do not pay federal taxes at the “corporate level”, but rather pass along the profits and losses to the business owners themselves, who are then taxed at their individual rates. The current top personal tax rate is 39.6%. Under the President’s plan, the personal tax brackets would be lowered with a range of 10, 25 and 33 percent. The House’s plan proposes personal rates of 12, 25, and 33 percent.
President Trump’s proposal will reduce the tax rate for pass-through entities to 15%. While not addressed in his April 26th proposal, candidate Trump indicated that there would be a second layer of taxes imposed similar to how dividends are now taxed to C corporation shareholders. These rates can range from 0% to 20% for qualified dividends and are taxed at the taxpayer’s ordinary rates for non-qualified dividends.
The House’s version of the plan would limit the tax rate applied to small business and pass-through income to a proposed 25 percent bracket. However, businesses will pay or be required to pay reasonable compensation to their owners. This compensation would be deductible by the business and would be subjected to the graduated individual income tax rates set forth in the House’s proposal.
As I mentioned earlier, these proposals have not been passed as law yet. So it’s important for small business owners to wait until the bill is finalized and read the details about specific tax changes to make the best decisions for their companies.