Table of contents
This article was reviewed by CPA Jaimie Goette.
If you’re a small business owner, you’re likely familiar with the 20% small business deduction. As the name implies, this deduction takes 20% off of your business income when calculating taxes, which can lead to huge savings on your taxes.
However, this tax deduction is scheduled to expire at the end of 2025. Unless Congress acts to extend the deduction, officially called the 199A Pass-Through Deduction or Qualified Business Income (QBI) Deduction, business owners who have met the qualifications for this deduction in the past should be prepared for a higher tax bill next year. Here’s a closer look at the 199A Pass-Through Deduction and other tax changes we may see for 2025.
The 199A Pass-Through Deduction: Why it matters
The 199A deduction went into effect for the 2018 tax year. Qualifying small businesses, real estate income trusts (REIT) dividends, and publicly traded partnerships are potentially eligible for the 20% deduction. Simply put, if you are eligible for the maximum benefit, your taxes are calculated as if you earned 20% less income from those sources.
If you operate a sole proprietorship, LLC, partnership, or S corporation, you may be able to take advantage of this deduction. For example, if you own an LLC and earn a $100,000 in profit, you would pay taxes as if you earned $80,000. That can add up to thousands of dollars in tax savings.
If you have questions about how the QBI applies to your tax situation, you may benefit from consulting with an accountant or other licensed tax professional.
What happens if the deduction isn’t extended?
The QBI deduction was a temporary provision of the Tax Cuts and Jobs Act (TCJA). It was passed during Trump’s first term as president by a Republican-led Congress, so there’s a possibility the tax cuts will be extended or made permanent before the end of 2025. As far as your small business taxes are concerned, that’s the most ideal outcome.
On the flip side, losing the 20% deduction could be costly to qualifying businesses and consumers. According to the National Federation of Independent Businesses (NFIB) 2024 Tax Survey, 61% of small business owners say they would raise prices, and 44% would postpone or cancel investments if the QBI deduction expires.
Unlike the temporary provision for pass-through entities, the TCJA put permanent tax rate changes in place for organizations operating as C-corporations. The top corporate rate was cut from 35% to 21%. With that in mind, some businesses have considered changing to a C corporation structure which, in some instances, could have a better tax result if the QBI is allowed to expire.
However, as the deduction may be extended, many CPAs believe that change would be premature. The best option for most businesses is to manage their finances in case the QBI goes away, but not to make any major changes to their business structure just yet.
Additional tax changes that could affect small businesses
The TCJA included more than just the 20% small business deduction. Here’s a look at other temporary provisions that could change if the law expires at the end of 2025.
- Higher individual tax rates: The TCJA lowered income tax rates for most tax brackets. Most filers would see their marginal tax rates increase by about 3%.
- Lower standard deduction: The TCJA increased the standard deduction dramatically, thus also increasing the threshold for itemized deductions. If the temporary provisions expire, the standard deduction would almost half the amount established in the TCJA, potentially leading to higher taxes for households that don’t meet the threshold to itemize deductions on their annual tax return. The standard deduction would be cut in half for 2025 taxes.
- Repeal of SALT limit: There’s a silver lining for those in high-tax states like California, New York, and New Jersey. They could see relief with an expiration of the State and Local Tax (SALT) $10,000 limit. As many small business owners run into the SALT limit, an end to this cap could offer an offset to a lost 20% QBI deduction.
What’s next? The political and economic outlook
Republicans generally support extending 2017 tax law provisions, particularly the 199A deduction. With the GOP in control of Congress, there’s a good chance we’ll see these tax breaks renewed. However, the outcome remains uncertain as lawmakers debate the financial impact.
Republicans are on a cost-cutting mission across the federal government, and extending the TCJA provisions could contradict their goals. But with a history of tax-cutting, we have to wait and see. According to the Treasury Department, ending the Small Business Deduction would save the government $673 billion over the next decade. Extending all TCJA tax cuts would cost $4.2 trillion over the same period.
How small businesses can prepare for tax uncertainty
Small business owners can hope for the best but should be financially prepared if the 20% deduction expires. You can take these steps to prepare for the 2025 tax year.
- Cash flow and budgeting: Start by reviewing your budget and cash flow. Ensure your business is sustainable regardless of whether the tax cuts are extended. Be prepared for a higher tax bill for 2025 taxes (filed in 2026).
- Build personal and business savings: Put your savings on autopilot with automated budgeting using Square Savings. Square Banking Balance Folders help you automate your business savings. Adding a Balance Folder dedicated to taxes can help you cover the costs when tax time comes.
- Meet with a tax professional: An accountant can help you understand your tax situation with or without an extension of the 20% deduction. A Certified Public Accountant (CPA) can also help you understand your options to convert to a new business entity.
- Keep up with political developments: Follow the news from Washington to follow updates about changes to the tax code. Whether the 2017 tax law expires, is extended, or is even made permanent, staying in tune with tax regulations can help you be prepared for whatever comes next.
Get your business ready for the future
The government seems to be changing faster than ever, and while 2025 is well underway, there’s no certainty about our tax rates for the next season. With chaos in Washington, the best we can do is prepare for higher taxes while hoping for a pleasant surprise. Regardless of political outcomes, preparation is key to minimizing tax burdens and maximizing financial stability.
Block, Inc. and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied upon for tax, legal and accounting advice. Consult your own tax, legal and accounting advisors for guidance related to your own business.
