Starting a New Business under the New Tax Law
Starting up a new business is an exciting but stressful time. Unfortunately, what you might have learned in business school about choosing a business structure, deducting net operating losses (NOLs) and depreciating assets may no longer be accurate under the Tax Cuts and Jobs Act. It’s important to seek guidance from your tax and legal advisors to make tax-savvy choices for your startup.
Under the new law, C corporations are taxed at a flat 21%, and the corporate alternative minimum tax (AMT) has been eliminated. These permanent changes make old-fashioned C corporations more attractive than under prior law.
But the new qualified business income (QBI) deduction of up to 20% for 2018 through 2025 helps level the playing field for “pass-through” entities, such as sole proprietorships, partnerships, limited liability companies and S corporations. The QBI deduction is subject to various rules and limitations.
Within those limitations, there are some planning strategies to consider. For example, you can adjust your business’s W-2 wages, convert independent contractors to employees, or invest in short-lived depreciable assets to maximize your QBI deduction.
Start-ups tend to generate net operating losses (NOLs) as they ramp up operations. NOLs happen when deductible expenses exceed income for the tax year. Under the TCJA, for NOLs that arise in tax years beginning after December 31, 2017, the maximum amount of taxable income for a year that can be offset with NOL deductions is generally reduced from 100% to 80%. In addition, NOLs that arise in tax years ending after 2017 can no longer be carried back to an earlier tax year (except for certain farming losses). Affected NOLs can be carried forward indefinitely.
Important note: Congress is expected to issue additional guidance on the NOL provisions of the new law. Contact your tax advisor for the latest developments.
In addition, a new limitation applies to deductions for “excess business losses” incurred by noncorporate taxpayers. Losses that are disallowed under this rule are carried forward to later tax years, and then they can be deducted under the rules that apply to NOL carryovers. This new limitation applies after applying the passive activity loss rules. However, it applies to an individual taxpayer only if the excess business loss exceeds the applicable threshold.
Starting a business also may require you to purchase fixed assets, such as office furniture, operating equipment, vehicles and computers. In general, you’ll be able to deduct more for capital expenditures in the first year they’re placed in service, and, in some cases, depreciate any remaining amounts over shorter time periods. Two key tax breaks allow for accelerated expensing:
- Expanded Section 179 deductions. Under the TCJA, for qualifying property placed in service in tax years beginning after December 31, 2017, the maximum Sec. 179 deduction increases to $1 million (up from $510,000 for tax years beginning in 2017) and the Sec. 179 deduction phaseout threshold increases to $2.5 million (up from $2.03 million for tax years beginning in 2017). The TCJA also expands the definition of property that’s eligible for Sec. 179.
- More generous first-year bonus depreciation. Under the TCJA, for qualified property placed in service between September 28, 2017, and December 31, 2022 (or by December 31, 2023, for certain property with longer production periods), the first-year bonus depreciation percentage is increased to 100% (up from 50% in 2017). The 100% deduction is allowed for both new and used qualifying property. In later years, the first-year bonus depreciation deduction is scheduled to be gradually reduced and then eliminated.