For the first time in 30 years, we have sweeping changes in income tax law! On December 22, 2017, President Trump signed into law the “Tax Cuts and Jobs Act of 2017” (“TCJA”). Unlike tax acts of recent years, TCJA will require significant additional guidance through legislation, Treasury Regulations and other agency interpretations. However, given that TCJA will affect nearly all taxpayers, I have summarized selected provisions that are expected to impact most businesses. Generally, the business provisions are effective for years beginning after 2017. Many of the provisions are permanent, but some provisions sunset after a period of years. Certain exceptions are identified below, and others are sprinkled throughout the text of the TCJA. (Note: We have a similar blog on the individual-related impacts. Click here to read more.)
Corporate tax reform was the cornerstone of the President’s plan, and Congress did not disappoint him with the TCJA. To begin, the corporate tax rate is lowered to a flat 21 percent. Previously, tax rates were graduated from 10 percent to 35 percent. The rate reduction is expected to produce substantial tax savings for C corporations.
In addition to a reduced corporate rate, the TCJA has eliminated the alternative minimum tax (AMT) for corporations. Not only will this produce tax savings, it will also simplify the calculation for many small and midsized businesses with significant AMT adjustments.
The initial framework originally suggested that corporate tax reform occur first and individual tax reform would follow. However, the President and Congress quickly realized that pass-through entities (i.e., partnerships, limited liability companies and S corporations) represent a significant part of the business community. Since pass-through entities are a hybrid of the personal and business tax regimes, a hybrid solution was enacted.
20 percent Deduction
The specific provisions of the new pass-through law are fairly complicated and will require regulatory guidance to understand how Treasury will implement the TCJA provisions. In general, however, pass-through owners will receive a 20 percent deduction on their personal return, based on the qualifying income reported from the pass-through entity. Qualifying income includes business income, cooperative dividend income and certain income from publicly traded partnerships. Specifically excluded are dividend and investment interest income, capital gains (short and long term), income from annuities and other similar investment-type incomes. Additionally, reasonable compensation or guaranteed payments to an owner claiming the 20 percent deduction will not be eligible for the favorable treatment.
This 20 percent deduction is from adjusted gross income (AGI), and therefore, it does not reduce AGI of the taxpaying owner. However, the deduction will be allowable whether or not the taxpayer itemizes on his or her personal return. Thus, it is expected to be a separate line item on the return from the itemized or standard deduction line.
For owners with AGI in excess of $157,500 ($315,000 for married filing joint taxpayers), additional calculations are required based on Form W-2 wages paid and tangible business assets. The details of this calculation are beyond the scope of this blog – look for more information in this additional blog.
It is important to note, that while this deduction is calculated and reported on the personal return, the deduction will be permanent, despite the fact that much of the individual reform sunsets after 2025.
Personal Service Businesses
For certain personal service businesses, including those in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, and others where the principal asset is the reputation or skill of one or more employees, the deduction may not be available. Engineering and architectural services are specifically excluded.
Subject to income phase-outs, certain owners of these personal service businesses may claim the pass-through deduction. However, the deduction begins to phase out when the taxpayer’s AGI exceeds $157,500 ($315,00 for joint filers) and is completely phased out at $207,500 and $415,000, respectively.
The pass-through deduction is an income tax deduction and does not reduce income for the purpose of calculating self-employment tax.
Section 168(k) Bonus Depreciation:
Over the last 15 years, Bonus Depreciation has come in and out of the Internal Revenue Code at varying rates. The first-year depreciation provision has been as low as 30 percent and as high as 100 percent. It has always been limited to new equipment (i.e., not previously owned). Under the TCJA, the write-off is again at 100 percent, but it now includes both new and used assets with useful lives of 20 years or less. This treatment applies to assets acquired and placed into service after September 27, 2017 and before January 1, 2023.
Section 179 Deduction:
In addition to the Bonus Depreciation provisions, the TCJA also enhances the Section 179 deduction. The limitation is increased to $1,000,000 (compared to $510,000 in 2017) and begins phasing out when asset additions exceed $2,500,000 (compared to $2,050,000 in 2017). These amounts are indexed for inflation beginning with the 2019 tax year.
In addition to the increased amounts, Section 179 is now available for lodging, which was previously not allowed (except for hotels). There are also additional benefits for certain improvements to commercial real estate.
Simplified Accounting for Certain Small Businesses:
For businesses with average annual gross receipts of $25,000,000 or less for the past three years, TCJA allows for the following simplified accounting methods:
- C corporations may use the cash basis method of accounting (previously, the limit was $5,000,000);
- Businesses with inventories may use the cash basis method of accounting;
- Simplified methods for accounting for inventory;
- Exemption from applying UNICAP; and
- Taxpayers with qualified long-term contracts may choose to use the completed contract method (previously, the limit was $10,000,000).
We are awaiting guidance about how such changes will be administered by the Treasury. In the meantime, since such changes may require extensive analysis, it is wise to begin considering how applying one or more of these changes to your business will affect your taxable income for future years.
Section 1031 Like-Kind Exchanges:
Section 1031 allows for nonrecognition of taxable gains in the event proceeds from a qualifying asset sale are properly reinvested in like-kind property. Historically, this has included real property and other business-use or income-producing property. Under the TCJA, effective for transactions closed after 2017, only real property that is held for trade, business or investment will qualify for nonrecognition.
The TCJA repeals the deduction for entertainment expenses incurred after 2017, specifically including:
- Any activity generally considered to be entertainment, amusement or recreation;
- Membership dues to any club organized for business, pleasure, recreation or social purposes; and
- A facility or portion of a facility used in connection with the above items.
Please note this repeal does not apply to the deduction for 50 percent of the food and beverage expenses associated with operating a trade or business.
Domestic Production Activities Deduction:
Effective for tax years beginning after December 31, 2017 (December 31, 2018 for C corporations), the TCJA repeals the domestic production activities deduction under Section 199 of the Code. For those businesses in the manufacturing, construction and agriculture industries, this represents the loss of a significant deduction.
Weighing in at just over 400 pages, the above summary only touches the surface of the changes imposed under the TCJA. Further, the practical implementation awaits additional legislative and agency guidance. Our firm is continually monitoring these developments and will issue additional commentaries as we receive and digest those materials. In the meantime, please feel free to reach out to our professionals should you have specific questions on these provisions or others you believe may have an impact on your business situation.