Consult your accountant, but an income pass-through shows promise for franchisees.
5 min read
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In the final days of 2017, the long-awaited tax reform bill was passed by Congress and signed into law by President Trump. The Tax Cuts and Jobs Act (TCJA) went into effect at the start of the year, and there has been much discussion about who comes out ahead in the new plan. While the answer to that may depend on factors such as marital status, the amount and type of deductions taken and the state in which they live, the consensus is that the new law will help businesses throughout the United States.
Much of the focus of the tax bill has been (and continues to be) on the reduction of corporate tax rates, which went from graduated rates, ranging from 15 percent to 35 percent, to what is now a flat 21 percent rate. However, as a franchise coach, I work with many small-business owners who are also impacted by the new tax law, so I have been scrambling like everyone else to learn as much as I can as quickly as I can.
With help from financial experts, I’ve learned that, in addition to the corporate tax rate, the new law has deductions for pass-through businesses, which apply to the vast majority of franchises — more than 2,000 franchisors and 200,000 franchisees.
While I am neither an accountant nor a proven expert on taxes/finances, I did want to give current and prospective business owners an idea of why the TCJA is important and what it means for them. So, I did bring in an expert — FranFund’s Geoff Seiber — to help me reveal the five things small business owners need to discuss with their accountant about the new tax bill.
Which part of the new tax code do we need to pay special attention to?
Under previous law, net taxable income from pass-through business entities (such as sole proprietorships, partnerships and S-corporations and LLCs) was passed through to owners and then taxed at the owners’ applicable tax rates. There was really no special treatment applied to pass-through income recognized by business owners.
The Tax and Jobs Cut Act (TCJA) now allows pass-throughs to deduct up to 20 percent of income. The exception to this business income reduction is for service-based businesses, such as realtors, doctors and lawyers, in which the 20 percent deduction is only available for married couples filing jointly with incomes up to $315,000 or $157,500 for single taxpayers. The pass-through deduction was included as an individual income tax provision, which expires at the end of 2025.
How will these changes affect business owners like me?
Overall, the TCJA has been viewed as very positive for many business owners. The new 20 percent deduction for pass-through businesses will have an estimated annual tax savings of $2.5 billion to the franchise community, according to the International Franchise Association.
The new measure provides business owners with a substantially increased tax break that will help them compete with larger businesses and global competitors that have a smaller tax burden. The new law incentivizes businesses to grow and invest in equipment, allowing full expensing for five years and increasing the small business expensing cap from $500,000 to $1 million.
If I want to open a small business, will these changes make it easier for me?
Yes. Many people believe one of the goals of the bill was to encourage people to become self-employed or entrepreneurs. There will be more liquidity because people can better anticipate what their tax liabilities will be. The lending environment is very positive right now. People with good credit will be able to get good rates. By being able to expense many of the items needed to start a business, it especially helps franchise owners with the structure already in place to get things up and running in the first year. As a result, lenders see less of a risk factor when financing the start of a business.
Will the new tax law be beneficial for me as an established business owner?
The new tax law provides existing owners greater incentive to grow their business and add units. Business owners can use their tax savings to hire new employees, increase employee wages and incentives, invest in new equipment, expand their workspace, pay down debt or reduce their prices.
What changes should I expect, both in the short term and over the next year?
Right now, there is a great deal of uncertainty to the application and compliance of the new law. Although it has already gone into effect, there will be an initial time period in which people will try to learn more about the tax plan and adjust accordingly. Owners may need to do a restructuring of some of their business decisions, such as how much income they take in as a salary versus how much they take as a pass-through.
Initial analysis of the Tax and Jobs Cut Act indicates small-business owners stand to benefit the most from the new law, particularly those looking to start a business or for existing franchisees wanting to expand their units. To understand the extent of how the TJCA will impact their individual business, it is recommended that business owners consult with their accountants and tax professionals as soon as possible to learn more.