Tax reform is the word out of Washington lately, as the Republican-controlled Senate and House of Representatives have passed the largest overhaul of the U.S. tax code in over 30 years. President Trump signed the bill into law on December 22nd.
In this blog, we’ll talk about how the tax reform plan could affect businesses, specifically staffing firms.
The House and Senate Bills
The House of Representatives passed their version of tax reform in mid-November. The main goal of the 440 page “Tax Cuts and Jobs Act” was to lower the corporate tax rate in order to encourage businesses to stay in the US and be competitive. It reduced the corporate rate from 35% to 20%, and also dropped the rate for “pass-through” businesses – aka S Corporations, LLCs, and partnerships – to 25%. The plan got rid of many itemized business deductions and credits, and included tax breaks such as the ability to deduct all costs of purchasing new equipment for five years. It collapsed the current seven tax brackets down to just four: 12 percent, 25 percent, 35 percent and 39.6 percent.
The Senate passed their version of a tax bill of the same name in early December. It is similar to the House bill in that it cuts the corporate rate and offers large tax breaks to pass-through corporations, allowing them to deduct 23% of their income. It differed in a few key ways, including that it: did not eliminate the alternative minimum tax; made the new lower tax rates sunset in 2025; repealed the individual health insurance mandate of the Affordable Care Act; and created seven income tax brackets, as opposed to the House’s four, that expire after 2025.
Congress has said that the $1.5 trillion in tax cuts will pay for themselves through economic growth and additional Federal revenue. Several nonpartisan reports such as one from the Joint Committee on Taxation contradict that projection and indicate that the bill will add at least $1 trillion to the deficit and grow the economy slower than Republicans project.
The Final Bill
Republicans revealed the final plan on December 15th which is a compromise between the Senate and House bills. It also includes new provisions that did not come from either previous version. President Trump signed the bill into law on December 22nd, making good on his promise to enact tax reform before Christmas. Some key features of the new law include:
- Permanent reduction in the corporate tax rate to 21% from the existing 35%. The cut would take effect immediately.
- Allowing pass-through businesses to deduct 20% of their income tax free. Deduction expires after 2025.
- Repeal of the individual mandate of the Affordable Care Act. This change doesn’t take effect until 2019, meaning that people will still pay the penalty for this year.
- Ability to write off the cost of new buildings and equipment. Businesses get full and immediate expensing, but the provision will begin to phase out after five years.
- Ability to deduct $10,000 in state and local property, sales, or income taxes off their federal bill.
- Interest on mortgages up to $750,000 will be deductible under the new law, a change from the $1 million current cap.
- Repeal of the corporate alternative minimum tax.
- Seven individual tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and a top rate of 37%.
- Double the standard deduction (from $6,500 for individuals and $13,000 for families to $12,000 and $24,000, respectively); expires at the end of 2025.
The House and Senate both passed the Tax Cuts and Jobs Act on December 19, although the House has to go for a revote after Democrats in the Senate persuaded the chamber's parliamentarian that several minor provisions in the House bill violated Senate rules. It passed again, and was signed into law on December 22nd.
Some parts of the law will take effect immediately. For instance, the lower income rates means less money will be withheld from paychecks starting early in the year. But most changes won’t go into effect until you file 2018 taxes in 2019.
What it Means for Staffing
As most small to midsize staffing firms are either partnerships, LLCs, or S Corps rather than large corporations, the pass-through tax treatment is where many staffing owners are directing their attention. 95% of American businesses are organized as pass-through entities, including most of the 20,000 or so staffing firms in the US.
The way that both chambers approached the pass-through issue was different. Under the Senate proposal, it was a 23% deduction, and on the House offered instead a maximum tax rate of 25%. The ultimate compromise was a 20% deduction, while the top personal rate is lowered to 37%. The result should put the marginal tax rates paid by pass-throughs fairly close to on par with the marginal tax rates paid by corporations.
While the House bill removed the Work Opportunity Tax Credit (WOTC), which many staffing firms use if they hire individuals from groups that historically face hiring barriers, the final bill preserves this tax credit.
Reaction to the bill among small business advocates was mixed, with some groups praising the measure, and some saying the bill does not go far enough to help small businesses and instead favors large corporations to the detriment of smaller players. Most businesses including staffing firms welcome tax breaks, and the Trump tax reform plan could end up being a boon to business owners. How much remains to be seen.