The Tax Cuts and Jobs Act (TCJA) is a sweeping reform of the tax code that was signed into law by president Donald Trump in Dec. 22., 2017. The new tax law includes mostly tax breaks, reduction of tax rates and significant increases in personal deductions for individual taxpayers.
Tech businesses, just like any other enterprise and regardless of structure, are likely to benefit from the changes. The legislation of the tax reforms was seen as a way of encouraging businesses to expand and hire more workers.
If a tech business is registered as a corporation, the most important change brought by the Act is the lowering of the Corporate Tax rate from a previous high of 35%, down to a new low of 21%.
Major TCJA Reforms that Allow Greater Reductions on Taxable Business Income
The TCJA modified the following allowable deductions to pose as significant tax reliefs, mainly because they can greatly reduce the taxable income of corporations and/or pass-through businesses.
Pass-through businesses by the way, are usually small or medium-sized enterprises in any industry. They are registered either as a sole proprietorship, partnership, limited liability company (LLC) or S-Corporation. Their main difference from traditional or C corporations is that income generated by the business, passes on as taxable income of the business owner/s, and not of the corporation.
Lump-Sum 20% Deduction on Qualified Business Income
Owners of pass through businesses can apply a lump-sum 20% deduction to further reduce their taxable income. However, this tax relief is available only when the taxable income is less than $157,500 and if the business owner is single; or less than $315,000 for married business owners.
100% Depreciation on Capitalized Expenditure
Capitalized expenditures are those that form part of the assets of the business rather than treated as outright expenses for the year. Traditionally, capitalized expenditures are gradually depreciated over a specific life and only the depreciation for the year gets recognized as an expense that can reduce the taxable income of a business.
The TCJA modified this method of recognizing depreciation expenses by allowing corporations and pass through businesses to treat the full cost of an acquisition on the very first year; instead of spreading them out as depreciation expenses throughout the life of the asset.
This tax amendment encourages businesses to further invest on computers, vehicles and other cost-intensive equipment and major property renovations.
Modification on the Treatment of Net Operating Loss (NOL)
Prior to the enactment of the TCJA, a resulting Net Operating Loss or NOL can be carried back for up to two years. Now, when a business incurred losses instead of profit during the tax year, the NOL amount can apply as further reductions on the taxable income on next year’s tax return. In case, the business incurs another NOL on the next tax year, they can be added to the previous year’s NOL onward, and for an indefinite period of time.
However, this tax relief is something that business owners must work out with a seasoned tax consultant, since the Internal Revenue Service (IRS) is not inclined to readily accept NOLs at face value. Expect an IRS examiner to carefully scrutinize the tax return in order to ascertain the propriety of all deductions made against the gross profit.