The House Ways and Means Committee recently released new tax proposals with a variety of provisions that impact small businesses. While there were some wins regarding estate planning or real estate investing vis-à-vis the original proposals, business owners are getting the short end of the stick with potential increases to their tax bill. How can small businesses prepare for these potential changes?
What is being proposed?
Let’s look at what changes are being proposed. As it stands, when an investment in a partnership goes bad it is considered an ordinary loss and an ordinary loss can offset any type of income. The new provision would change this to a capital loss which is impactful. Unlike ordinary losses, capital losses can only offset capital gains. Additionally, if you’re a successful business owner with more than $400,000 in income, you could see a reduction in your gain exclusion when you sell. The proposal would reduce the Section 1202 gain exclusion from 100% to 50%. That is not the only limitation that is on the horizon. The popular 20% deduction for passthrough entities, the Qualified Business Income Deduction QBID, would be capped at $500,000. Currently, there are no limitations on the QBID other than the limitations on which industries qualify for this deduction. Finally, the net investment income tax would apply to passthrough business income over $500,000 which are exempt under current tax law. This adds another 3.8% tax on top of the income tax increases.
How to prepare for big changes
Will the tax proposals be passed as they currently stand? It’s possible they may shift slightly, however, what remains the same is the opportunity to proactively plan for these major tax changes. Any smart business owner will be taking time to meet with their tax advisor and attorneys to ensure that they’re updating their tax strategy appropriately, so it’s critical that you schedule time with your team while they have availability during what will surely be a busy fourth quarter. Tax planning is complicated and can take months to complete effectively, so the sooner you begin the better.
What strategies can be implemented?
President Biden has long said that those making less than $400,000 in income will not see an increase in tax, so business owners should approach their planning with the goal of reducing their taxable income to $400,000 or less. There are a variety of ways to legally do so including bonus depreciation on real estate and other business investments, oil and gas investing and adding solar panels to your buildings. A well-educated tax advisor will be able to share the best methods based on your current income and business.
Remember, the tax law is a series of incentives for business owners and investors. While the new proposal may create new challenges, there are many legal tax strategies that can reduce and eliminate your taxes when implemented properly. Now is the time to begin revamping your strategy and preparing for potential tax changes.
Tom Wheelwright is a CPA, CEO of WealthAbility®, Best-Selling Author of Tax-Free Wealth (Rich Dad Advisors Series), Speaker, Entrepreneur and Host of 2 popular podcasts: The WealthAbility® Show with Tom Wheelwright CPA and The WealthAbility® for CPAs Show.