Due to the quick passing of the Tax Cuts and Jobs Act, many taxpayers and members of the business community are still trying to figure out what’s in the bill, what will impact them, and what actions should be taken to best position their businesses in 2018.
There’s a lot to consider, so we’ve highlighted the tax reform changes that’ll likely have the greatest impact on businesses.
C corporations
- The income tax rate is reduced to a flat 21% from a maximum rate of 35%.
- The 80% and 70% dividends received deductions are reduced to 65% and 50%, respectively.
- A blended tax rate will apply to fiscal year-end corporations in order to account for the reduced corporate rate. The blended rate is based on a formula that calculates the number of days of your fiscal year that were in 2017 and 2018.
- The alternative minimum tax (AMT) is repealed. You may use minimum tax credits from 2017 to offset regular tax liability.
- C corporations that issue financial statements using generally accepted accounting principles (GAAP) will see an additional impact from the new tax law. As of December 2017, all deferred tax assets and liabilities must be restated.
Pass-through entities
Taxpayers who have certain domestic qualified business income from a partnership, S corporation, or sole proprietorship can deduct 20% of qualified business income. Trusts and estates are also eligible for this deduction.
- This deduction is limited to either 50% of wages or 25% of wages plus 2.5% of the cost of tangible depreciable property for qualifying businesses, whichever is greater.
- The 50% of wages limitation doesn’t apply if the business owner’s total taxable income is less than $315,000 (married filing jointly) or $157,500 (single).
- Businesses related to health, law, accounting, actuarial science, performing arts, consulting, athletics, and financial or brokerage services aren’t eligible for this deduction. But, if the business owner’s total taxable income is less than $315,000 (married filing jointly) or $157,500 (single), he/she is eligible for the deduction.
- The technical termination or type B termination for partnerships is repealed. Termination occurs when 50% or more of the total interest in partnership capital and profits is sold or exchanged.
Depreciation
- Bonus depreciation is allowed for 100% expensing of qualified property placed in service after September 27, 2017 and before January 1, 2023. Qualified property now includes used property acquired by the taxpayer.
- The Section 179 deduction is $1 million with the phaseout threshold starting at $2.5 million. These amounts will be indexed for inflation starting in 2019.
- Depreciation limits for passenger automobiles placed in service after December 31, 2017 are increased. These amounts will be indexed for inflation starting in 2019. The year one limitation is $10,000.
- Farming businesses are not required to use the 150% declining balance method for property placed in service after December 31, 2017. The recovery period for machinery and equipment is five years.
- Qualified improvement property now has a 15 year recovery period if placed in service after December 31, 2017. The separate definitions for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property are eliminated.
- Qualified real property includes all qualified improvement property and certain improvements made to nonresidential real property. Certain improvements include roofs, HVAC property, fire protection or alarm systems, and security systems.
- The MACRS depreciable lives remain the same for noresidential and residential property. Lives are 39 and 27.5 years, respectively.
- The nonrecognition of gain for like-kind exchanges will only apply to real property for exchanges completed after December 31, 2017.
Entertainment
- The deduction for entertainment, amusement, or recreation is repealed, even if it directly relates to the active conduct of trade or business. And, the deduction for club membership dues or the cost of a facility related to entertainment, amusement, or recreation is withdrawn.
- The 50% deduction for food and beverage expenses associated with operating a trade or business is still available. Now, the deduction includes expenses associated with providing food to employees through an eating facility and must meet the de minimis fringe requirements.
- The deduction for meals provided for the employer’s convenience, on or near the place of business, is reduced to 50%.
Employee benefits
- Employers can no longer deduct expenses for qualified transportation fringe benefits given to employees. Deductions for providing transportation, payment or reimbursement for travel between an employee’s residence and workplace, parking, transit, vanpooling, and qualified bicycle reimbursement are not permitted. There’s an exception for expenses that are necessary for ensuring an employee’s safety, but the term isn’t defined in the bill.
- Employees can’t deduct unreimbursed business expenses on their personal income tax return. This includes any auto expenses incurred by an employee under an accountable plan that exceeds employer reimbursements.
- Individuals can’t deduct moving expenses. Moving expense reimbursements made to an employee are treated as taxable wages to the employee.
- Any employee achievement award of value must be included in the employee’s income. Awards of value include cash, gift certificates, vacations, event tickets, etc. There are some exclusions for value of other tangible property.
Interest deduction
- The interest expense deduction is limited to 30% of a business’ adjusted taxable income. Adjusted taxable income is calculated regardless of depreciation expenses, amortization, depletion, or the 20% deduction for pass-throughs.
- Businesses are exempt from this limitation if they have average annual gross receipts of $25 million or less.
- Rental activities and farming businesses can elect to be excluded from this limitation. To qualify, they must use the alternative depreciation system (ADS) for depreciating assets.
Other deductions
- The domestic production activities deduction (DPAD) is repealed.
- Deductions aren’t allowed for any payments made that are related to sexual harassment or abuse if the payments are subject to a nondisclosure agreement. Settlements or attorney fees are also not permitted.
Net operating losses
- Net operating losses (NOLs) can’t be carried back if they arise after December 31, 2017. They can be carried forward indefinitely.
- Farming NOLs can be carried back two years.
- NOL deductions are limited to 80% of taxable income if they arise after December 31, 2017.
Excess business loss
- Losses are limited to $500,000 for married filing jointly taxpayers and $250,000 for all other taxpayers.
- This limitation applies at the partner or shareholder level, but doesn’t apply to C corporations.
- Unused loses can be carried forward under the NOL rules. The limitation will be indexed for inflation in future years.
Credits
- The research and development credit is preserved.
- The rehabilitation credit is retained with some changes.
- A 12.5% credit for wages paid to qualifying employees for paid family and medical leave was added.
Accounting methods
- The cash method of accounting is available to any entity with average gross receipts less than $25 million for the previous three years. Inventories still need to follow the accrual method.
- The UNICAP requirement to account for certain costs in inventories has been removed for entities with average gross receipts less than $25 million for the previous three years.
- The requirement to use the percentage-of-completion accounting method for long-term contracts increases to a $25 million average gross receipts test for contracts entered into after December 31, 2017. Businesses that meet this exception are permitted to use an exempt method – including the completed contract method – to account for their long-term contracts.
- The $25 million limit will be indexed for inflation. You may need to file an accounting method change with the IRS to take advantage of the expanded rules.
Additional tax reform changes
- Aircraft – Certain payments related to private aircraft management are exempt from excise taxes imposed on taxable air transport.
- Qualified Equity Grants – The tax code permits an election to defer income from qualified stock transferred to an employee. Various rules and requirements must be met to qualify.
- The Interest Charged Domestic Sales Company (IC-DISC) structure is retained. This is a way to capture tax savings on goods manufactured in the U.S. and shipped to foreign countries.
- The inflation adjustments in the bill will be calculated on chained consumer price index (CPI). This will slow the pace of the inflation adjustment.
Your business is unique, so your response to this tax reform should be as well.
Have questions about tax reform and how it’ll impact your business? Let’s talk!
