This is part 5 of a 5 part series about the Tax Cuts & Jobs Act.
By Travis McMurray
The Tax Cuts and Jobs Act of 2017 (“TCJA”) affects a broad cross-section of the Internal Revenue Code and will impact nearly every income tax filer. Many of the more complex provisions relate to business tax returns. As we look at some of the highlights from the business tax provisions of the new tax bill, it’s important to remember that most all of the changes are or the 2018 tax year or later. Furthermore, we still don’t know some key details regarding the application of certain provisions. The IRS must analyze the bill and issue revenue rulings further defining and refining some of the provisions and revising and creating tax forms. Here are some of the key TCJA changes which will affect business tax filings:
- Corporate tax rate changes – For tax years beginning after Dec. 31, 2017, the corporate tax rate has been changed to a flat 21%. Previously, the corporate tax rates where on a graduated scale that were designed to max out at 35%. Under the graduated brackets, the first $50,000 of income had been taxed at 15%.
- Corporate Alternative Minimum Tax – For tax years beginning after Dec. 31, 2017, the corporate AMT is repealed.
- Modification of net operating loss (NOL) deduction – For NOLs arising in tax years ending after Dec. 31, 2017, the two-year carryback and the special carryback provisions are repealed, but a two-year carryback applies for certain losses incurred in the trade or business of farming. NOLs generally can be carried forward indefinitely. For losses arising in tax years beginning after Dec. 31, 2017, the NOL deduction is generally limited to 80% of taxable income. Carryovers to other years are adjusted to take account of this limitation.
- Increased Section 179 expensing – For property placed in service in tax years beginning after Dec. 31, 2017, the maximum amount a taxpayer may expense is increased to $1 million, and the phase-out threshold amount is increased to $2.5 million. The definition of qualified real property eligible for Code Sec. 179 expensing is also expanded to include the following improvements to nonresidential real property after the date such property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems. Also any other building improvements to nonresidential real property that aren’t elevators or escalators, building enlargements or attributable to internal structural framework are Code Sec. 179 property.
- Temporary 100% bonus depreciation – A 100% first-year deduction for the adjusted basis is allowed for qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023. The additional first-year depreciation deduction is allowed for new and used property.
- Domestic Production Activities Deduction (DPAD) – For tax years beginning after Dec. 31, 2017, the Code Sec. 199 DPAD is repealed.
- Business entertainment expenses – For amounts paid or incurred after Dec. 31, 2017, deductions for entertainment expenses are disallowed, eliminating the subjective determination of whether such expenses are sufficiently business related.
- Limited deduction for meals – For amounts paid or incurred after Dec. 31, 2017 and before 2026, the current 50% limit on the deductibility of business meals is expanded to meals provided through an in-house cafeteria or otherwise on the premises of the employer. The deduction is repealed beginning in 2026.
- No deduction for amounts paid for sexual harassment settlements – For amounts paid or incurred after Dec. 22, 2017, no deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement.
- Accounting method changes – Generally for tax years beginning after Dec. 31, 2017, a taxpayer is required to recognize income no later than the tax year in which the income is taken into account as income on an applicable financial statement (AFS) or another financial statement under rules specified by IRS. For tax years beginning after Dec. 31, 2017, the cash method of accounting may be used by taxpayers (other than tax shelters) that satisfy a $25 million gross receipts test, regardless of whether the purchase, production, or sale of merchandise is an income-producing factor.
- Accounting for Inventories – For tax years beginning after Dec. 31, 2017, taxpayers that meet a $25 million gross receipts test are not required to account for inventories, but rather may use an accounting method for inventories that either (1) treats inventories as non-incidental materials and supplies, or (2) conforms to the taxpayer’s financial accounting treatment of inventories.
- Limits on deduction of business interest – For tax years beginning after Dec. 31, 2017, every business, regardless of its form, is generally subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income. Under a small business exception, the business interest limitation doesn’t apply to taxpayers (other than tax shelters) for a tax year if the taxpayer’s average annual gross receipts for the three-tax year period ending with the prior tax year don’t exceed $25 million.
- New deduction for pass-through income – For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the Act adds a new deduction for noncorporate taxpayers for qualified business income-also referred to as the “pass-through deduction.” The deduction reduces taxable income, rather than adjusted gross income (AGI), but is available to taxpayers who take the standard deduction. The deduction is generally 20% of a taxpayer’s qualified business income (QBI) from a partnership, S corporation, or sole proprietorship. . Certain types of investment related items are excluded from QBI including capital gains, dividends, and interest income. Compensation to a shareholder or guaranteed payments to a partner are also excluded. The deduction with respect to service businesses is phased out if the taxpayer’s taxable income exceeds the threshold amount of $157,500 ($315,000 in the case of a joint return). Taxpayers whose taxable income exceeds the threshold amount of $157,500 ($315,000 in the case of a joint return) are also subject to limitations based on the W-2 wages and the adjusted basis in acquired qualified property.
These changes are only some of the highlights from the Tax Cuts and Jobs Act. As the IRS releases specifics on the application of many of these provisions, it will be important to evaluate the overall structure of any business entity.