2025 Tax Outlook for Businesses and Their Owners

The Republicans will soon control the White House and both chambers of Congress, likely opening the door for major tax legislation next year. Here are some thoughts on how this power shift could affect the taxes of small businesses and their owners.

Extension of TCJA Provisions

The Tax Cuts and Jobs Act (TCJA), which became effective in 2018, included many important federal income tax provisions affecting small businesses and their owners. Some are scheduled to expire at the end of 2025, while others are permanent. Republicans are expected to extend many of the expiring provisions, including:

Individual tax rates on business income. The TCJA retained seven tax rate brackets under pre-TCJA law, but five rates are lower than before. These rates generally apply to an individual taxpayer's:

• Net taxable income from a sole proprietorship or from a limited liability company (LLC) that's treated as a sole proprietorship for tax purposes
• Share of net income passed through from a partnership, an LLC treated as a partnership for tax purposes, or an S corporation

For 2025, the tax rates for ordinary income are as follows:

2025 Federal Tax Rates on Ordinary Income and Short-Term Capital Gains

In 2026, the rates and bracket edges in place for 2017 (with cumulative inflation adjustments) are scheduled to return unless future legislation is enacted to change that outcome. When the Republicans take control of Congress in 2025, the TCJA rates for individuals will probably be extended — and the top rate will likely stay at the current 37%.

QBI deduction. Before the TCJA, net taxable income from sole proprietorships, partnerships, and LLCs was treated as sole proprietorships or partnerships for tax purposes. S corporations were passed through to the owners and taxed at owners' standard federal income tax rates. The TCJA established a new deduction based on a noncorporate owner's qualified business income (QBI) from these businesses. This tax break is available to individuals, estates, and trusts.

Under current law, a deduction of up to 20% of QBI may be available. However, it's subject to limitations that may apply at higher income levels. The QBI deduction isn't allowed when calculating a noncorporate business owner's adjusted gross income (AGI), but it reduces taxable income. It's treated the same as an allowable itemized deduction, though you're not required to itemize to benefit.

The QBI deduction is scheduled to expire after 2025, absent congressional action. However, the Republican-controlled Congress will likely extend this tax break — or they might liberalize it or make it permanent.

First-year depreciation tax breaks. For qualified property, the TCJA initially increased the first-year bonus depreciation percentage to 100% for eligible assets. After 2022, first-year bonus depreciation is still available, but the bonus depreciation percentages are reduced as follows:

• 80% for property placed in service in calendar year 2023
• 60% for property placed in service in calendar year 2024
• 40% for property placed in service in calendar year 2025
• 20% for property placed in service in calendar year 2026

First-year bonus depreciation is scheduled to vanish after 2026 without congressional action. However, there's a good chance the new Congress will extend or revive it. President-Elect Donald Trump has even proposed returning to 100% first-year bonus depreciation for qualifying capital investments.

In addition, Trump has floated the idea of doubling the ceiling on the Section 179 expensing deduction for small businesses' qualifying investments in equipment. The TCJA permanently capped the deduction at $1 million, adjusted annually for inflation ($1.22 million in 2024 and $1.25 million in 2025). The deduction is subject to a phaseout when the cost of qualifying asset additions exceeds $2.5 million, adjusted annually for inflation ($3.05 million in 2024 and $3.13 million in 2025).

C Corporation Tax Rate

The TCJA permanently established a flat 21% corporate rate for C corporations, which applies to personal service corporations (PSCs). Before the TCJA, C corporations paid graduated federal income tax rates of 15%, 25%, 34%, and 35% on taxable income. When taxable income exceeded $10 million, the effective tax rate was a flat 35%. PSCs paid a flat 35% rate on all taxable income.

Trump campaigned to lower the corporate tax rate from 21% to 15% for corporations that make their products in America. However, whether he has congressional support for this proposal is currently unclear.

R&E Expenditures

In 2022, the TCJA brought a significant permanent change to the tax treatment of research and experimentation (R&E) costs under Internal Revenue Code Section 174. Under current law, businesses no longer have the option to deduct so-called "specified R&E expenses" (those paid or incurred during the tax year). Instead, they must amortize these costs over five years if incurred in the United States or 15 years if incurred outside the country. Amortization continues even if the underlying property is disposed of, retired, or abandoned during the applicable period. In addition, software development costs now must be treated as Sec. 174 expenses.

Making matters even more complicated is a provision requiring that the amortization period begin at the midpoint of the tax year in which the expenditures are incurred or paid. As a result, taxpayers can deduct only 10% of expenses in the first year and 20% of expenses in years two through five, with the remaining 10% deducted in year six.

R&E expenditures generally include research and development (R&D) costs in the experimental or laboratory sense. Applicable costs also include those incurred in efforts intended to discover information that would eliminate uncertainty about the development or improvement of a product, including salaries.

Important: Sec. 174 defines R&E expenditures more broadly than R&D expenses for Sec. 41 R&D tax credit purposes. So, costs not covered by the credit may still be considered R&E expenditures. That means Sec. 174 may apply to a business regardless of whether it claims the credit.

Before the TCJA went into effect, a business could either:

• Deduct R&E expenses in the year they were incurred
• Capitalize and amortize the costs over a minimum of five years

Software development costs could be expensed immediately. They could also be amortized over five years from completion or over three years from the date the software was placed in service.

The new Congress may try to restore the option to deduct R&E costs. Bipartisan support exists for this change because this TCJA provision has adversely affected many small businesses.

Specifically, the provision has caused many companies — particularly those in the life sciences and technology sectors — to report taxable income, even if they incur losses. In January 2024, the House passed the Tax Relief for American Families and Workers Act (H.R. 7024) by a vote of 357-70. The bill would have temporarily restored the previous Sec. 174 immediate expensing option through 2025 on a retroactive basis for domestic R&E expenses. The Senate never voted on the bill. The new Congress will likely revisit the issue.

Additional Tax Proposals

President-Elect Trump proposed various tax law changes on the campaign trail that could affect employers' payroll tax obligations if enacted. Examples include:

• Eliminating taxes on tips paid to restaurant and hospitality workers
• Eliminating taxes on overtime pay
• Eliminating taxes on firefighters, police officers, active-duty military members and veterans

However, Trump didn't provide any details on possible rules and restrictions. If these changes are enacted, employers presumably wouldn't have to pay federal payroll taxes on tax-free payments.

In addition, Trump generally doesn't support the various "green" energy tax subsidies implemented over the last few years, including the tax credit for "clean" commercial vehicles. He's promised to dismantle the Inflation Reduction Act (IRA), including cutting unspent funds allocated for the law's tax incentives for clean energy projects. However, Republicans from districts and states with significant clean energy projects planned or underway may push back on a full repeal of the IRA. Congress might propose retaining some of the IRA tax credits or restricting them through tighter eligibility requirements as a compromise.

Finally, the president-elect has repeatedly pledged to impose a baseline tariff on imported goods. In his latest proposal, he stated that he would impose a 25% tariff on products from Canada and Mexico and additional tariffs on imports from China. During the campaign, he made several other proposals. Trump routinely claims that the exporting countries will bear the cost of the tariffs. However, U.S. companies that buy imported goods pay the tariffs and will likely pass them along to their customers. Some major U.S. companies and the National Retail Federation have warned that Trump's tariff proposals would increase product prices.

Wait and See

It's currently unclear whether Republicans can deliver on their campaign promises. But, with the looming expiration date of many TCJA provisions, 2025 is certain to be a landmark year for federal tax legislation. Contact us to stay atop the latest developments and devise tax planning strategies for your business to optimize your tax outcome.

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