UPDATES FROM THE TAX CUTS AND JOBS ACT
Is your Business Ready?
With 2018 quickly coming to a close, it’s important to take some time to understand how the Tax Cuts and Jobs Act will affect your business.
Passed in November of 2017 and taking effect in the 2018 tax year, the Tax Cuts and Jobs Act is arguably the most significant update to US tax law in the last 30 years. While the majority of the bill focuses issues related to individual taxation, there are many changes for businesses as well. Changes range from minuscule, industry-specific tweaks to dramatic game-changers that have the potential to be big money savers. By understanding how the TCJA affects you and your business, you can avoid surprises come April 15th, take advantages of the new tax features, and help your business succeed.
The biggest changes relate to changes in tax rates for C-corporations, the popular new Section 199A deduction (the “20% deduction”), and favorable depreciation options.
A separate discussion of issues related to individual taxation can be found here.
Tax Rates – The new law eliminates the old bracket structure, which had rates ranging from 15% to 35%, in favor of a flat tax. All corporations will now be taxed at 21%, regardless of income level. Corporations with income in the lowest bracket under the old system (15%, for corporations with income below $50,000) will experience a higher marginal rate. All others will see a reduction.
$0 to $50,000
$50,000 to $75,000
$75,000 to $100,000
$100,000 to $335,000
$335,000 to $10,000,000
$10,000,000 to $15,000,000
$15,000,000 to $18,333,333
Pass-through entities, which are taxed at the individual partner / shareholder level, will also enjoy generally more favorable rates due to changes in the tax brackets for individuals. For more information on these changes, see our article on individual taxation linked above.
Alternative Minimum Tax (AMT) – The corporate AMT has been repealed. Note that the AMT for personal returns has been retained, however.
Capital Gains – Generally, C-corporations do not receive favorable tax rates on capital gains like individuals do. Some corporations (those with very high income) previously received slightly favorable rates. This treatment is eliminated under the new law. For all corporations, capital gains income will be taxed at the same 21% as other income going forward. Note that for partnerships, S-corporations, and sole proprietors, capital gains are taxed only at the individual level. As discussed in the article on changes to individual taxation, capital gains treatment for individuals remains effectively unchanged by the new law. Thus, such entities are not affected here.
Like-Kind Exchanges –In the most basic terms, a like-kind exchange is when a taxpayer sells a piece of property and buys another similar piece of property in a short amount of time (or vice-versa). If specific requirements are met, the two transactions are essentially treated as one single exchange for tax purposes and any gains are either nontaxable or deferred. Under previous law, many types of property were eligible for like-kind exchange treatment. Under the new law, only real estate is eligible for this treatment going forward.
Bonds – A few special types of tax-exempt bonds are no longer receiving favorable treatment. Tax credit bonds and direct-pay bonds can no longer be issued (existing bonds remain and are still tax exempt). Refunding bonds will no longer be eligible to be tax exempt. Holders of such bonds will find they are a less attractive investment going forward. Note that this may also affect your individual income taxes if you invest in these types of securities in your personal portfolio.
Self-Created Works – Certain self-created works (specifically patents, inventions, models, designs, etc.) were previously classified as capital assets. Gains on the sale of such works thus received preferential capital gains rates compared to ordinary gains. Under the new, assets are no longer classified as capital assets. Going forward, gains on the sale of such works will be treated as ordinary gains.
Depreciation – There have been several changes to the treatment of depreciation. Depreciation has been given its own section below.
Dividends Received Deduction – Presently, C-corporations receiving dividend income from other corporations are allowed a deduction equal to 70% of the income received. Under the new law, the deduction is reduced to 50%. The purpose of the deduction was to mitigate the effect of double taxation. The change weakens that benefit.
Domestic Production Activities Deduction – The domestic production activities deduction (DPAD) is eliminated altogether.
Employee Achievement Awards – Previously, employers could deduct the cost of achievement awards given to employees. The deduction was limited to $400 per employee per year. The employee recognized no income unless gifts exceeded $1,600 in total. To curb attempts to disguise bonuses and other compensation as achievement awards, the new law explicitly states that cash, securities, gift cards, coupons, etc. are NOT achievement awards. The dollar limitations for both employer and employee remain in effect.
Interest Expense – The new law implements limits on the amount of certain types of interest expense that are deductible. Generally speaking, if interest expense exceeds 30% of your net taxable income, some of the interest expense will be disallowed (i.e. not deductible) but can be carried forward to use in the future. “Small entities” (those with less than $25 million in gross receipts) are exempt from this limitation.
Meals & Entertainment Expenses – These expenses have historically been limited to being only 50% deductible. Under the new law, business meals remain 50% deductible. Entertainment expenses, however, are no longer deductible at all.
Moving Expenses – Under old law, if an employee was compensated / reimbursed for qualified moving and relocation costs, the reimbursements were excluded from income on their personal tax return. The new law eliminates the exclusion. All reimbursements for moving and relocation expense are now taxable to the employee.
Net Operating Loss Deduction – A loss incurred by a C-corporation forms the basis of a net operating loss (NOL). Previously, such losses could be “carried back” up to 2 years and applied against positive income on prior returns (by amending those returns) or “carried forward” to apply against future income. The new law eliminates carryback and allows for indefinite carryforward. However, NOL deductions in future periods can now only eliminate up to 80% of future taxable income. For example, a $200 loss in 2018 can be carried forward to use against income in 2019. If there was $150 of income in 2019, only 80% * $150 = $120 of the $200 NOL available could be used. This leaves $30 taxable income in 2019. The residual $80 unused NOL can be carried forward to 2020.
NOL carryback period
No carryback allowed. Carryforward only.
2 years. Can elect out to carry forward only.
NOL carryforward period
Up to 20 years
NOL deduction allowed
Limited to 80% of taxable income.
Up to 100% of taxable income.
Qualified business income (QBI) may be eligible for up to a 20% deduction. QBI generally would include income from a sole proprietorship, S-corporation, partnership LLC, or a rental property. For example, if your share of partnership income is $100, you may only have to pay taxes on $80 of income. Traditional C-corporations are NOT eligible due to being taxed separately and having already received a favorable rate reduction. The deduction is subject to several limitations, making the calculation very complex. “Back of the napkin” calculations will be difficult here. Limitations factor in such things as: taxable income on your personal return, capital gains income on your personal return, total W-2 wages paid to your employees, total cost of depreciable property, and the nature of the business. It should be stressed that 20% is the maximum possible deduction. Even some profitable and otherwise eligible businesses may receive 0% deduction. Further, since the calculation involves elements of your personal return, it’s possible that equal partners may receive entirely different deductions (e.g. one might get the full 20% and the other might get nothing).
Importantly, the calculation of the deduction is done at the individual level rather than the business level, i.e. the deduction will be taken on your personal return rather than the business return. For pass-through entities (LLCs, partnerships, and S-corporations), there are new reporting requirements necessary to facilitate calculations. K-1’s received from such entities must report the owner’s share of following: qualified business income (QBI), total W-2 wages paid to employees, unadjusted basis of property Immediately after acquisition (UBIA), and specified service trade or business income (SSTB). Sole proprietors and single-member LLCs will arrive at these numbers while preparing their Schedule C.
Limitations can be roughly summed up as follows:
- If the total wages you pay your employees is considered too low relative to your net income, your deduction is limited
- If some of your income is from SSTBs, your deduction is limited. This applies to doctors, lawyers, accountants, financial service provides, and other highly skilled service providers.
- If the potential deduction exceeds your taxable income (ignoring capital gains), your deduction is limited.
Personal Taxable Income
W-2 Wages & UBIA Limitation
Taxable Income / Capital Gains Limitation
Deduction not subject to limitations
Deduction not subject to limitations
$315,000 to $415,000
SSTB income starts to become ineligible
Limitation partially phased in
$415,000 and up
SSTB is completely ineligible
Limitation in full effect
By default, the deduction is calculated on an entity-by-entity basis, not an aggregate basis. There will be a separate deduction calculation for each K-1 received, each rental property, and each Schedule C business. However, the taxpayer may elect to aggregate multiple similar or related activities. Election possibilities are quite flexible – you can aggregate some, all, or none. You can even create multiple groups. Due to the complex nature of the calculations, aggregating may or may not be beneficial. “What if” scenario calculations will be a valuable exercise to determine if there are tax-saving opportunities to be had. Note, however, that once made, the aggregation election is permanent.
Assets acquired by a business are generally either expensed immediately or depreciated (i.e. expensed over several years). Three main methods of depreciation exist: traditional depreciation, “bonus” depreciation, and Section 179 expense elections. The latter two were designed to accelerate the rate of depreciation, allowing a business to deduct the cost of the asset more quickly. Regular depreciation is accounted for after bonus depreciation and Section 179 expensing.
Bonus Depreciation – Bonus depreciation allows for immediate depreciation of a certain % of an asset’s cost in the year of acquisition. The new law retains this feature with some changes.
- Bonus depreciation is set to 100%, up from 50% in 2017. This means you can fully depreciate an asset in the first year.
- You can now take up to $1,000,000 of total bonus depreciation, up from $500,000 in 2017
- Bonus depreciation was set to phase out to 0% starting in 2018 under the old law. The new law begins phase out starting in 2023.
- Both new and used property are eligible under the new law. Previously only new property was eligible. Note that “used” here means purchases of previously owned property, not property already in service.
Section 179 Expensing – Section 179 expensing allows a business to elect to immediately expense a new asset rather than to capitalize and expense over time. The new law retains this feature with some changes.
- Total maximum Section 179 expense allowable has been increased from $500,000 to $1,000,000.
- Ability to elect section 179 expensing is phased out starting at $2,500,000 in total new assets, up from $2,000,000 under previous law.
- Certain assets (listed property) are have limitations on total depreciation allowable. The new law increases the amount of Section 179 expensing that can be taken on listed property. This mostly notably affects automobiles.
- The new law retains an important limitation: total Section 179 expense is limited to business’s total income. Any disallowed excess can be carried forward and used in future years.
Note that, while they sound similar, 100% bonus depreciation and full expensing under Section 179 have some fine differences beyond the scope of this e-mail.
Regular Depreciation – A new asset category has been created for qualified improvement property (QIP) – a generic term for improvements to building interiors. The definition of QIP was meant to allow for more favorable treatment of such property. Based on discussions during the drafting process and notes in the Conference Committee’s reports, the intent of the new law was to make this category depreciable over 15 years. This would’ve made QIP eligible for 100% bonus depreciation. However, due to an oversight, the specific language necessary to make the change was omitted in the final bill. Thus, qualified improvement property retains a 39 year life. We hope there will be administrative correction of this issue, but for now we are stuck with 39 year QIP.
One credit has been created. Only two existing credits received modifications, and no credits were repealed.
Historic Rehabilitation Tax Credit – Credit previously consisted of two parts: A) 20% of qualified expenses related to rehabilitation of a certain certified historic structures and B) 10% of qualified expenses related to rehabilitation of a qualified building (built pre-1936), with a max $5,000 credit. The new law repeals the 10% credit and changes the 20% credit to be spread over 5 years.
Orphan Drug Credit – Credit amount is reduced from 50% of qualifying expenditures to 27.5%.
Credit for Paid Family and Medical Leave – This is a new credit to incentivize employers to provide family and medical leave to their employees. The credit is temporary in nature and will expire after the 2019 tax year. Requirements on an employer’s policies regarding leave must be met to claim the credit. For example, employers must have a formal written policy on family / medical leave, paid leave must be at least 50% normal wages, and the minimum leave time allowed must be at least two weeks. The credit ranges from 12.5% to 25% of wages paid to qualifying employees during family and medical leave, depending on the percentage paid in relation to normal wages (i.e. if you offer 100% paid leave, you get more credit than if you paid only 50% normal wages). Leave for higher-income employees will not qualify, unfortunately.
Technical Terminations – Previously, certain events could trigger a technical termination of a partnership, such as major changes of ownership within 12 month period. Technical terminations have been eliminated under the new law, which should allow for smoother ownership transfers going forward.
Cash-Basis Accounting – Businesses typically use one of two main methods for their accounting – cash-basis or accrual-basis. Cash-basis accounting, generally considered the easier of the two to implement, records revenues only when cash is received and expenses only when paid, with limited use of receivables and payables reporting. The previous law forbade certain entities from using the cash basis of accounting. The new removes some of these restrictions, allowing more businesses to use the cash basis of accounting. In particular, all “small entities” (entities with less than $25 million in average gross receipts) can now use this method. Note that while tax law may allow cash-basis, other obligations may still necessitate the use of accrual-basis accounting. For example, if your bank requires an annual audit or you work with HUD properties.
Other Changes – Large chunks of the new law relate to specific industries and activities that are beyond the scope of this email. Feel free to get in touch with us separately to discuss the impact on your specific business.
As you can see, there’s plenty to digest. Not every change will apply to your business, but those that do can have a big impact. While many of the bigger changes are generally positive, there is a push-pull dynamic with other changes. If you’d like more information on how the changes may impact your specific business, feel free to contact our office.
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