The new tax law passed by Congress contains many changes that will affect most taxpayers.
The vast majority of these changes will affect your personal, not your business taxes. These changes will go into effect in 2018, not 2017.
Let me first address one rumor that has been going around saying that providers will lose the ability to deduct many of their business deductions. Not true! The rules regarding what is an “ordinary and necessary” business expense remains the same. That means you can continue to deduct house-related expenses, food, toys, furniture, etc.
Also, despite the new limitations on the deductibility of property taxes and mortgage interest (see below) this will not affect the ability of providers to continue to deduct their Time-Space Percentage of property taxes and mortgage interest as a business expense.
There are three major changes that may affect your business taxes:
The 50% bonus depreciation rule has been increased to 100% for the next five years and then will be phased out over the following five years.
This means you can fully deduct, rather than depreciate, any new item you purchase that is used in your business, except for a home. It also applies to most home improvements (See my article on this.)
This is a big deal! For example, if you spent $5,000 to buy a new fence or furnace or replaced your central air conditioning unit and used it 40% for your business, you can deduct $2,000 in the first year ($5,000 x 40% = $2,000) and not have to depreciate it.
Note: Under the old law, the 50% bonus depreciation was set to drop to 40% in 2018 and drop further in subsequent years. Recently I wrote an article telling providers to buy items they would normally have to depreciate in 2017, rather than 2018, to take advantage of the higher tax deduction. But, the new tax law makes it more beneficial to buy new items in 2018, rather than 2017!
2) Pass-Through Deduction
Family child care providers who are self employed (sole proprietor), or set up as a partnership, Limited Liability Company (LLC) or S Corporation pay business taxes (usually 15.3% Social Security/Medicare taxes) on their profit as well as federal income taxes on the same profit.
Providers can now escape from paying federal income taxes on 20% of their business profit on Form 1040!
Let’s say a provider made a profit of $40,000 on her Schedule C as a sole proprietor. Under the 2017 tax law she will pay $5,651 in Social Security/Medicare taxes and pay federal income taxes on $40,000. Under the 2018 tax law she can reduce her federal taxable income by $8,000 ($40,000 x 20%) and only pay federal taxes on $32,000 of income. She will still pay the same $5,651 in Social Security/Medicare taxes.
This pass-through deduction may be limited if you are single and your profit is above $157,500 or $315,000 married filing jointly.
The amount of federal taxes you will save after this deduction will depend on what tax bracket your family is in. Your state may or may not allow you to use this rule to reduce your state taxable income.
3) Corporate Tax Rate Decline
The tax rate on corporations has dropped to 21%. Since the vast majority of providers are not incorporated as a C Corporation, this change will not affect them. But, providers who are in personal tax brackets that are higher than 21% may be tempted to incorporate to get a lower tax rate.
In general, I don’t think it’s a good idea to incorporate to get a lower tax bracket unless you understand all the tax as well as legal consequences to incorporating. Consult with a lawyer and accountant before taking this step. My objections to incorporating are described my article, “Should You Incorporate Your Business?”
1) Child Tax Credit
This credit is for parents who have child dependents. It’s different than the Child Care Tax Credit which is for parents who pay someone else to care for their child while they work. The Child Care Tax Credit has not increased.
The Child Tax Credit is currently $1,000, and has been expanded to $2,000 for 2018. If you are single you are eligible if your adjusted gross income is less than $200,000 (up from $75,000) and $400,000 if you are married (up from $110,000). $400 of the additional $1,000 is refundable, which means you can get the credit even if you don’t owe any taxes.
2) Standard Deduction/Personal Exemptions
The personal standard deduction has increased from $6,350 to $12,000 for single providers and from $12,700 to $24,000 for married providers filing jointly.
This change will mostly benefit lower income providers who will no longer have to itemize their expenses and can now claim the higher standard deduction.
However, at the same time, the law eliminates personal exemptions that were worth $4,050 in 2017. This will offset part or all of the increase in the higher standard deduction. Let’s say you are married with one child and your adjusted gross family income was $70,000. Under the 2017 law your federal taxable income is reduced by $12,700 (standard deduction) and $12,150 (personal exemptions) for a new taxable income of $45,150 ($70,000 – $12,700 – $12,150). Under the new law your $70,000 income would only be reduced by $24,000 for a new total of $46,000. So, this family is worse off! Single providers or married providers with no dependents (children are living away from home) will benefit the most from these changes.
3) Caps on Mortgage Interest Deduction and State/Local Tax Deductions
Providers who have high mortgage interest and state and local tax deductions may be limited in their ability to claim as much under the new law. Interest on home loans are now limited to homes costing $750,000 or less (down from $1 million). This change does not affect your current mortgage, it only affects new mortgages.
The personal deduction for state and local taxes will be limited to $10,000. Again, these changes do not affect your ability to deduct the same business deduction for mortgage interest and property taxes on your Form 8820 Expenses for Business Use of Your Home.
4) New Lower Tax Brackets
The federal tax brackets have been modified – starting in 2018 there will a 10%, 12%, 22%, 24%, 32%, 35%, and 37% bracket. These changes will mean that most providers will pay less taxes as a result.
5) No Mandate to Purchase Health Insurance Under the ACA
Update: The mandate ends as of 2019, not 2018 as my article originally stated. Under current law taxpayers must either purchase health insurance under the Affordable Care Act or pay a small penalty. Starting in 2019 this mandate is eliminated. Providers should carefully consider the consequences of not having insurance before dropping their insurance policy. The long term consequences of fewer people buying insurance will be higher insurance premiums.
These are significant tax changes and it will take awhile for their full impact to be understood. I expect to see a lot of clarifications and suggested strategies for how best to take advantage of these changes to arise over the next year or two. As I learn new information, I will write more about this.
There are many other provisions in the new tax law that don’t affect providers. They mostly benefit the wealthy and large corporations
Tom Copeland – www.tomcopelandblog.com