2018 Tax Changes (Explained as Best as Humanly Possible)
To put it very (very) mildly, the new tax bill is not without its problems. In their newsletter attempting to explain the new bill's changes, the American Institute for Public Bookkeepers (AIPB) wrote, "Warning: You are encouraged to wait, where possible, for IRS guidance to confirm the details below. There are many technical errors in this tax law."
We have tried our best to explain how a few of these various changes might affect your business. In the interest of keeping this an article and not a book, we'll be summarizing many of the details, with links to articles where each piece can be expanded upon in greater depth.
To begin, here are a few of the easiest changes.
Mileage rates. The standard business mileage deduction has been raised from 53.5 cents per mile to 54.5 cents per mile.
Listed property. Computers and peripherals are no longer listed property, and therefore do not have to be held to the same proof of exclusive business-use standards as, for example, vehicles.
Meals & Entertainment. From 2018 through 2025, on-premise meals for employees will be reduced from 100% deductible to 50% deductible. As of 2026, they will no longer be deductible at all. Most entertainment expenses are no longer deductible.
Getting a bit more in-depth...
Income from pass-through entities. Anything other than a C-Corp is now considered a pass-through entity (including S-Corps). Pass-through deductions on individual returns are also significantly changed, particularly for those higher-income earners in the fields of law, accounting, medicine, consulting, athletics, financial services, and brokerage services. More details can be found here, Can You Win From the Pass-Through Deduction?, and more details on other lines of businesses to be affected will hopefully be explained by new IRS amendments and regulations.
C-Corp income. You may already be aware that taxes for C-Corps have been significantly reduced, to a flat 21%. However, the deduction for dividends received from other corporations has also been reduced from 70% to 50% for most dividends, and to 65% for those dividends which had been previously deducted at 80%.
Depreciation changes. This is another area that has received a lot of coverage, as the changes here are extensive. For starters, tangible personal property has been expanded to include property primarily used to furnish lodgings and improvements to nonresidential real estate. (If you're in the hotel business, this should be very exciting news for you.) Furthermore, Section 179 and bonus depreciation have been increased, with new rules not only applying to 2018, but also to property purchased in 4th quarter 2017, or purchased before 4th quarter 2017 but not put into use until 2018. Unfortunately, most of the bonuses expire in five years. Forbes has a great write-up of these changes, Tax Geek Tuesday: Changes To Depreciation In The New Tax Law.
Business interest expense and income. The business interest deduction is now capped at 30% of income (excluding depreciation) and can be carried forward for five years. Small businesses are exempt if they have less than $25 million in annual gross receipts, or are cash-basis. It also does not apply to "any taxpayer in the business of being an employee" (IRS clarifications hopefully coming soon), or to real property/real estate businesses. Business interest income also no longer includes interest from investments.
And the information we either don't have, or which is too long to list here.
FITW. For starters, federal income tax withholding tables are not yet available, but are scheduled for this month, to be used for employee wages as early as February. These could mean for some significant changes in employee take-home pay, but we won't know exact details until they are released by the IRS. This can be a bit of a headache for small businesses handling their own payroll; if you are not currently using a payroll service provider, now might be a good time to research those options.
Fringe benefits. Many fringe benefits which previously counted as deductions for employers will now no longer be deductible. Additionally, certain expenses are no longer deductible for employees, as well (in particular, un-reimbursed business expenses). See The New GOP Bill and What It Means for Employee Benefits in 2018 for a list of the eliminated benefits.
With all of the changes to tax law in 2018, it's dangerous to try and navigate on your own. Talk to your accounting professional about how these changes will affect your business.
The Financial Reasons Small Businesses Fail
Almost every entrepreneur has heard the statistic: 80% of small businesses fail. There are many reasons this happens, and can include everything from market slumps to lazy owners. To enumerate every way a business can go under would be an endless, impossible task.
However, there are a few financial characteristics frequently found in struggling businesses. Here are the most common financial reasons small businesses fail.
There's no plan. It's not uncommon to meet new small business owners who have a brilliant product idea, a well-developed marketing plan, a slick website, and not one thought given to their budget. We've already written on the tough financial questions to answer before starting your own business, but the importance of a solid financial bedrock cannot be overemphasized. A well-researched budget and fixed goals is the key to surviving that crucial first year in which most businesses go under. Great customer service and spot-on marketing are not enough to balance out shaky financials.
Speaking of customer service...
Poor credit management and pricing strategies are bad for everyone. No one craves popularity like an entrepreneur and, when your business's success is entwined with how well-liked you are, the urge to avoid offending anyone becomes even stronger. In the early days of a business, when there are only a few customers, there is a common impulse to let clients slide on late payments, or to offer frequent "friends and family" discounts. It's easy to justify this with the logic with the idea that you need to establish customer loyalty, and you can tighten the reins a bit when you have a solid customer base. There are a few reasons this doesn't work:
- Clients who don't pay on time aren't going to appreciate the slack you've given them in the past; they are going to resent the restrictions you enforce in the future.
- Likewise, your patrons who are just coming to you for the lowest price will quickly go elsewhere when your rates rise.
Lenient accounts receivable and cheap pricing might gain you a quick boost in early sales, but they are not a sustainable model. Delivering a product you can be proud of, at a price that is worth your hard work and can keep your business afloat (and actually requiring customers pay you that fair price) ensures that your customers the pleasure of patronizing your business for years to come. Because you have to remember...
Cash is king. Yes, it's a cliche, but that doesn't make it any less true. A great business model matters little if you run out of money before you can implement it. Managing cash flow is key to not just the health but the continued existence of your business. Here are a few of the most common cash pitfalls small businesses face:
1.) Insufficient capital. In all likelihood, your business will not be immediately profitable. So not only do you need enough cash to get your business started, but you need enough to allow yourself to operate at a loss for a while.
2.) Not having a large enough cash cushion. Think "Princess & the Pea" levels of padding. Regardless of how well you plan, the economy is unpredictable. Look to history for examples. No one expected the Boston Molasses flood which, in addition to the damage caused and lives lost, resulted in a nearly $11M settlement (in today's money) for the responsible company.
3.) Over-investing in fixed assets. It's great to plan for the long-term but, if you don't plan for the short-term as well, your business will not get a long-term. Sacrificing too much of your cash for something like manufacturing equipment (even if you're getting a great deal) can hurt you, as that is not a liquid asset and will be of no help to you in the event of an emergency (i.e. your factory flooding a major metropolis with 2.3M gallons of molasses). Think of it like a game of Monopoly; if you start building hotels too soon and suddenly need cash, you're stuck selling all your buildings back to the bank for half-price, and you know bankruptcy is right around the corner. Only, in real business, instead of losing yet another game to your annoying brother-in-law, you've lost your entire livelihood.
Expanding your business is the ultimate goal, but maintaining cash flow gives you the solid foundation you need to build upon.
80% of new businesses fail, but that means 20% succeed. To be that 1 out of 5, have a plan, know your value, and remain patient. Better to start small and grow something big than to start too big and dwindle away.
Success Stories: The Client Who Wanted to Quit
We were once approached by someone with a small project. He was just interested in us "prettying up" his financials in preparation of selling his company. He was concerned that his business was not paying him the money he wanted to make, and had just received a new job offer for $60,000.
When pressed about it, he admitted that he wasn't terribly thrilled about this new job opportunity, but felt that he had to take it as, in his perspective, his only income from his current business was a $45,000 draw.
But when The Bookkeeper looked at his financials, we saw:
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Family's health insurance - $9,600
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Automotive payment - $9,120
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Auto, gas, insurance & repairs - $8,450
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Meals - $10,200
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Vacations - $7,700
When added to his draw, this amounted to a total monetary benefit $90,070.
This equates to $116,500 in total equivalent taxable income, instead of the $45,000 the client perceived.
When we met back with the client and illustrated to him how much he was actually making, he turned down the job offer, kept his business, and remained his own boss.