The House GOP recently released its tax reform plan that Republicans believe will ensure business growth and job creation for the foreseeable future.  While there are many changes that come with the tax plan, for this article, I will focus on a few major pieces.  To start the Corporate Tax Rate for top earners will decrease from 35% to 20%.  When it comes to corporate taxes America is on the higher end when compared to other developed nations, but the drop will drive up revenue and (hopefully) lead to job growth.  As for tax changes affecting small businesses, the major change is to the so called “pass through entity”.  Despite the GOP’s best efforts, the National Federation of Independent Businesses (one of the largest small business lobbying groups) has already come out against the new document.

According to the Financial Times, the NFIB “said it could not support the bill, expressing concern that 85 per cent of small businesses, which are structured not as corporations but as so-called “pass through entities”, would not benefit from the proposed lower 25 per cent rate aimed at them.”

So what is the new taxation of “pass through” business income?  Below is a quick example given from Business Insider:

Under the Republican plan, certain kinds of pass-through business income would be taxed at rates no higher than 25%. But to prevent abuse — for example, incorporating myself as Josh Barro LLC and selling “professional services” to Business Insider instead of taking a salary — there would be rules setting out what’s real business income and what’s labor income made to look like business income.

In general, owners who actively participate in their businesses would face a 70/30 rule: 70% of their income from the businesses would have to be treated like salary (and taxed at rates up to 39.6%) and only 30% of their income would enjoy the 25% preferential rate.

But professional services firms — like Josh Barro LLC — would have to treat 100% of the owner’s income as salary, taxable at up to 39.6%. Womp womp.

The goal of the tax seems to be focused on manufacturing / developing companies and other small businesses that are looking to reinvest in their businesses.  For diverse firms the big take away is that if you’re not looking to reinvest large sums into your company or if you run a professional services type firm, the new rules will not benefit you.  These include companies that provide services such as

  • Accounting
  • Training and development
  • Various types of Consultants
  • Law Firms
  • IT services
  • and more

According to Jack Mozloom by way of Business Insider, NFIB’s communications director, “about 85% of pass-through businesses wouldn’t benefit from the tax break, regardless of any guardrails, because their owners’ incomes are already low enough to enjoy a tax rate of 25% or less. He said NFIB was hoping for a graduated provision offering these business owners a preferential rate below 25%.”  In addition cost provisions such as the budget reconciliation instructions the House agreed to last week, making it so that “the Senate cannot use a simple majority to pass any tax bill that raises the deficit by more than $1.5 trillion over 10 years” creates problems.

There are many other issues as well, including the cut to many family deductions in an effort to pay for the large corporate cuts.

  • The bill abolishes the tax deduction for student loan interest paid.
  • It ends the adoption tax credit, a favorite provision of pro-family conservatives.
  • It lowers the cap on the mortgage deduction.
  • It does not change 401(k) contribution limits, avoiding one expected confrontation, but it still abolishes the deduction for state income taxes and caps the deduction for property taxes, which are major issues for Republicans representing high-tax states.
  • And a key middle-class friendly provision in the bill — a $300 credit for each taxpayer, spouse and non-child dependent — is set to run only through 2022.

There is still much to be done, but for now, for small businesses and in particular diverse businesses which are more on the professional services side.