The House Tax Cuts and Jobs Act introduced last week included a significant change to the taxation of pass-through business income: the income would be subject to a maximum taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. rate of 25 percent, representing a large tax savings compared to the current top marginal rate of 39.6 percent. But even with that large change, many in the pass-through community want to push the bill even further, arguing that small pass-throughs don’t benefit since most or all of their taxable income falls below the 25 percent maximum rate. While correct on the small point, advocates miss the greater tax reform picture. Small pass-through businesses would still benefit from a number of other changes.
First, the House Tax Cuts and Jobs Act lowers tax rates and expands bracket widths. Under current law, pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. income on a single filer’s return would hit the 25 percent bracket at $38,700 (in 2018). By comparison, the House Tax Cuts and Jobs Act expands the lower 15 percent bracket so the business would need $45,000 in income to hit the 25 percent bracket. For married filers, it would take $90,000 in income to hit the 25 percent bracket, compared to $77,400 under current law.
The standard deduction would be expanded under the House Tax Cuts and Jobs Act, potentially saving pass-through businesses on taxes. The current proposal would functionally double the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. to $24,400 for married filers in 2018, compared to $12,700. Individuals with pass-through business income who do not itemize would see this benefit as well. Coupled with the wider brackets described above, a pass-through business would need $114,400 in income to hit the 25 percent bracket, compared to $90,100 now.
Pass-through businesses would also see the benefit of the expansion of the Section 179 expensing provision. Currently, businesses are allowed to expense only $500,000 in property. The Tax Cuts and Jobs Act expands this to $5 million, ten times larger than current law. That would allow small business to write off many investments that they are currently not allowed to expense, reducing their tax liabilities. This is a significant expansion that would benefit many small businesses.
Finally, small businesses would see simplification under the House Tax Cuts and Jobs Act with the expanded limits on cash accounting. Currently, businesses are required to use accrual accounting if their gross receipts exceed $5 million, but the House Tax Cuts and Jobs Act would expand that to any business with gross receipts under $25 million. Farms see an even larger increase, from a $1 million to a $25 million gross receipts limitation.
These smaller pass-through businesses would not see the dramatic tax savings of their larger brethren, but there are many ways that they stand to benefit from the House Tax Cuts and Jobs Act as well.
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