Seven months have passed since Congress enacted the Tax Cuts and Jobs Act. The new law remains a subject of controversy, with policymakers, activists, and the media continuing to debate its effectiveness and repercussions. But among taxpayers – from individuals to business owners to nonprofits – the general feeling towards the tax bill is that of confusion. The vague language and complexity of many of the new provisions have left many scratching their heads, wondering if they’ll see any significant benefits on their tax returns as a result of this law.
As we move into the second half of the year, we’re gaining a little clarity, if not of the true impacts of the bill, at least on where the pain points lie and will be cause for concern going forward. For those of us in the microbusiness sector, the question is twofold: how is the new tax law affecting small businesses, and how is it affecting the organizations that serve them?
The Effect on Nonprofits
One issue facing nonprofits in the tax bill revolves around UBIT (Unrelated Business Income Tax), which refers to business income that is unrelated to the organization’s mission. For the first time, churches, synagogues, and other nonprofit organizations who provide certain benefits to their employees – such as transportation, parking, and gym benefits – will be subject to a 21 percent tax on these expenses under UBIT. So, for example, an organization that offers bus passes to its staff will either have to provide these benefits as taxable items to the employees or discontinue them altogether in order to avoid the UBIT liability.
Though the impact of this new tax is happening in real time since the law took effect in January, most organizations are still unsure of how to report these expenses. The language in the bill is vague and open to interpretation, making it impossible to know whether benefits such as on-campus university buses or a garage at a parsonage count as taxable costs. The IRS has yet to release clear and detailed guidelines on how to implement this new tax, creating a compliance burden that will weigh heaviest on smaller organizations.
Given the impact that this new tax could have on the nonprofit sector, many groups have already called on Congress, the Treasury Department, and the IRS to repeal or at least delay new UBIT liabilities until clear guidance is provided. Some Republican and Democratic representatives have responded to these calls and are introducing several bills to address the problem by repealing all or some of the new UBI taxes. If you would like to help keep up the pressure to make these changes happen, CalNonprofits details a few steps you can take.
The Effect on Small Businesses
One of the most touted aspects of the Tax Cuts and Jobs Act by its supporters was the “pass-through deduction.” This provision applies to businesses whose owners pass their business income through to their personal income tax returns, making them subject to individual income tax rates. Under the new tax law, these entities are eligible for a 20 percent deduction on qualified business income. Because sole proprietorships, partnerships, LLCs, and chapter S corporations – which account for 90 percent of small businesses – are considered pass-through entities, this new tax break is ostensibly a win for small business owners. But the reality is a little more complicated.
In order to qualify for the deduction, a business’ taxable income must be below $157,500 or $315,000 if the business owner is married and files jointly. For businesses whose taxable income exceeds those thresholds, the provision includes rules on what income is eligible for the deduction. Once again, the language in the bill is unclear and indeterminate, making it extremely difficult for countless business owners to correctly calculate their taxes. Until the IRS clarifies the rules on the pass-through deduction, this confusion will surely have tremendous consequences for small businesses since both overpaying and underpaying on their tax returns can create serious cash flow imbalances.
Furthermore, the pass-through deduction is scheduled to sunset after 2025. For a business to be truly confident in expanding, modernizing, and investing in its employees, long-term financial certainty is key – something for which the current tax law does not provide. On July 24, House Ways and Means Committee Chairman Kevin Brady (R-TX) released a framework for a proposed “Tax Reform 2.0,” which would include making permanent the pass-through provision as well as allowing brand-new businesses to write off more of their initial start-up costs. While these amendments would certainly improve upon the existing bill, they do not address its broader problems.
The Joint Committee on Taxation estimates that, in 2018, the pass-through deduction will account for $40 billion in tax breaks. 44.5 percent of that money ($17.8 billion) will go to just 200,000 business owners who make more than $1 million. According to Businesses for Responsible Tax Reform, “this means 1 percent of small businesses are receiving the lion’s share of the benefit.” Since the vast majority of small businesses pay low marginal tax rates, the dollar-for-dollar benefit they are receiving from this provision is not enough to hire more workers, raise wages, or reinvest in their companies.
Then there are the indirect effects that the tax law will have on small businesses as a result of its impacts on individual taxpayers. The bill considerably favored large corporations over workers, increased the cost of health insurance premiums, and will lead to a trillion dollar deficit which may eventually have to be paid for by cutting social programs. With less money in their pocket, consumers will be less inclined to spend it – and this will affect Main Street. “For my business to do well, my neighborhood has to do well,” said Jim Houser, co-owner of an auto shop in Portland, Oregon. “My company prospers when I have more customers who are prosperous, with rising incomes, like pay raises, and declining expenses, like lower health-care costs. This tax giveaway neither raises my customers’ incomes nor cuts their expenses.”
Although the full effects of the tax law on small businesses and nonprofit organizations remain to be seen, there is one expense that will be unavoidable and indispensable: hiring a tax professional. Due to the bill’s vague language and convoluted provisions, organizations that file their taxes without the help of an expert will likely lose out on the best tax rates and be at a competitive disadvantage to corporations that employ highly-paid accountants.
Research shows that small business owners prefer a fair tax system over tax cuts. The Tax Cuts and Jobs Act is neither fair to the average American worker nor does it provide significant tax relief for small businesses.