Business Tax reform update
What's New? What's Old (Gone)?
The final version of the Tax Cuts and Jobs Act has been approved by Congress and signature by the President is expected to be a formality. Therefore, it seems likely that we will have a new tax bill before Christmas. Happy Holidays!
Although almost all of the tax law changes are not effective until next year, some important expensing provisions will be effective immediately. It may also be advantageous to consider planning opportunities that impact 2017 and 2018.
The purpose of this tax alert is to identify the most significant business tax changes in the tax bill that may impact your situation.
Decrease in corporate tax rate
Among the most publicized changes in the act is the reduction of the highest corporate income tax rate from 35% to 21% after December 31, 2017.
The graduated corporate tax rate which started at 15% for the first $50,000 of taxable income and rose to 35% for corporation over $10,000,000 of taxable income has been replaced by a flat rate of 21%.
Tax benefit on business income of sole-proprietors, S corporation shareholders, and partners/members in partnerships/LLCs
In order to provide tax benefits to businesses that passthrough income and tax to their owners (passthroughs) Congress included legislation to provide a deduction for certain passthrough businesses. Therefore, the tax bill provides that sole proprietors, S corporation shareholders and partners/LLC members will be entitled to a deduction of up to 20% of their allocable share of qualified business income.
There several steps required to determine the actual deduction. The qualified business income excludes capital gains or qualified cooperative dividend. Qualified business income does not include payment to the taxpayer for services or guaranteed payments to a partner for services. The deduction is, also, limited to 50% of the W-2 wages or 25% of wages plus 2.5% tangible depreciable property. The W-2 wage limit begins being reduced at $315,000 for married couples or $157,000 for individuals.
The deduction is not available to certain service businesses including: the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services that exceed the limitation threshold of $315,000 for married couples or $157,000 for individuals.
This deduction will require significant guidance from the IRS before it appears on tax returns. It is not tax simplification.
100% expensing of business assets placed in service after September 27, 2017 and increase in automobile depreciation for auto acquired after that date.
Prior to the proposed tax bill the bonus depreciation rate for qualified property, generally new property with a depreciable life of 20 years or less and specified building improvements, placed in service in 2017 was 50%.
The proposed tax bill increases the bonus depreciation percentage to 100% for qualifying property, including used assets, placed in service after September 27, 2017. In addition, the limitation on depreciation with respect to certain passenger automobiles is increased to $10,000 from $8,000 for passenger automobiles acquired and placed in service after September 27, 2017.
Increased Code Section 179 Expensing
Under current law each taxpayer meeting the qualification can expense up to $500,000 of property placed in service for the tax year. The $500,000 amount was reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the tax year exceeds $2 million. These amounts were indexed for inflation.
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. For tax years beginning after 2018, these amounts (as well as the $25,000 sport utility vehicle limitation) are indexed for inflation. Property is not treated as acquired after the date on which a written binding contract is entered into for such acquisition.
“Qualified real property.” The definition of qualified property is expanded to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging. The definition of qualified real property eligible for 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.
Reduced Recovery period for Real Property
For property placed in service after Dec. 31, 2017, the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property are eliminated, a general 15-year recovery period and straight-line depreciation are provided for qualified improvement property, and a 20-year ADS recovery period is provided for such property.
Thus, qualified improvement property placed in service after Dec. 31, 2017, is generally depreciable over 15 years using the straight-line method and half-year convention, without regard to whether the improvements are property subject to a lease, placed in service more than three years after the date the building was first placed in service, or made to a restaurant building. Restaurant building property placed in service after Dec. 31, 2017, that does not meet the definition of qualified improvement property, is depreciable as nonresidential real property, using the straight-line method and the mid-month convention.
Limit 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. The net interest expense disallowance is determined at the tax filer level. However, a special rule applies to pass-through entitles, which requires the determination to be made at the entity level, for example, at the partnership level instead of the partner level.
Exemptions. An exemption from these rules applies for taxpayers (other than tax shelters) with average annual gross receipts for the three-tax year period ending with the prior tax year that do not exceed $25 million.
For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2022, adjusted taxable income is computed without regard to deductions allowable for depreciation, amortization, or depletion.
The amount of any business interest not allowed as a deduction for any taxable year is treated as business interest paid or accrued in the succeeding taxable year. Business interest may be carried forward indefinitely, subject to certain restrictions applicable to partnerships. The business-interest-limit provision does not apply to certain regulated public utilities and electric cooperatives. Real property trades or businesses can elect out of the provision if they use ADS to depreciate applicable real property used in a trade or business. Farming businesses can also elect out if they use ADS to depreciate any property used in the farming business with a recovery period of ten years or more. An exception from the limitation on the business interest deduction is also provided for floor plan financing (i.e., financing for the acquisition of motor vehicles, boats or farm machinery for sale or lease and secured by such inventory).
Like-Kind Exchange Treatment Limited
Generally effective for transfers after Dec. 31, 2017, the rule allowing the deferral of gain on like-kind exchanges is modified to allow for like-kind exchanges only with respect to real property that is not held primarily for sale. However, under a transition rule, the pre-Act like-kind exchange rules apply to exchanges of personal property if the taxpayer has either disposed of the relinquished property or acquired the replacement property on or before Dec. 31, 2017.
Limitation on Excessive Employee Compensation
A deduction for compensation paid or accrued with respect to a covered employee of a publicly traded corporation is limited to no more than $1 million per year. However, under pre-Act law, exceptions applied for: (1) commissions; (2) performance-based remuneration, including stock options; (3) payments to a tax-qualified retirement plan; and (4) amounts that are excludable from the executive's gross income.
New law. For tax years beginning after Dec. 31, 2017, the exceptions to the $1 million deduction limitation for commissions and performance-based compensation are repealed. The definition of “covered employee” is revised to include the principal executive officer, the principal financial officer, and the three other highest paid officers. If an individual is a covered employee with respect to a corporation for a tax year beginning after Dec. 31, 2016, the individual remains a covered employee for all future years.
Under a transition rule, the changes do not apply to any remuneration under a written binding contract which was in effect on Nov. 2, 2017 and which was not modified in any material respect after that date. Compensation paid pursuant to a plan qualifies for this exception if the right to participate in the plan is part of a written binding contract with the covered employee in effect on Nov. 2, 2017. The fact that a plan was in existence on Nov. 2, 2017 isn't by itself sufficient to qualify the plan for the exception. The exception ceases to apply to amounts paid after there has been a material modification to the terms of the contract. The exception does not apply to new contracts entered into or renewed after Nov. 2, 2017. A contract that is terminable or cancelable unconditionally at will by either party to the contract without the consent of the other, or by both parties to the contract, is treated as a new contract entered into on the date any such termination or cancellation, if made, would be effective. However, a contract is not treated as so terminable or cancellable if it can be terminated or cancelled only by terminating the employment relationship of the covered employee.
Corporate Net Operating Loss Deduction Modified
Under pre-Act law, a net operating loss (NOL) may generally be carried back two years and carried over 20 years to offset taxable income in such years
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 in the case of certain losses incurred in the trade or business of farming.
For losses arising in tax years beginning after Dec. 31, 2017, the NOL deduction is limited to 80% of taxable income (determined without regard to the deduction). Carryovers to other years are adjusted to take account of this limitation, with some exceptions, NOLs can be carried forward indefinitely.
Corporate AMT repealed
Corporate AMT would be repealed after December 31, 2017. Prior year Minimum tax credit would be allowed at 50% until 2021. The credit would be allowed to offset tax at 100% for 2022.
Domestic Production Activity Deduction repealed
The deduction for up to 9% of taxable income of certain business is repealed effective December 31, 2017.
Deduction for Entertainment Expense Deduction Modified
Under current law, a taxpayer may deduct up to 50% of expenses relating to meals and entertainment. Housing and meals provided for the convenience of the employer on the business premises of the employer are excluded from the employee's gross income. Various other fringe benefits provided by employers are not included in an employee's gross income, such as qualified transportation fringe benefits.
For amounts incurred or paid after Dec. 31, 2017, deductions for entertainment expenses are disallowed, eliminating the subjective determination of whether such expenses are sufficiently business related; 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; and deductions for employee transportation fringe benefits (e.g., parking and mass transit) are denied, but the exclusion from income for such benefits received by an employee is retained. In addition, no deduction is allowed for transportation expenses that are the equivalent of commuting for employees (e.g., between the employee's home and the workplace), except as provided for the safety of the employee.
For tax years beginning after Dec. 31, 2025, the Act will disallow an employer's deduction for expenses associated with meals provided for the convenience of the employer on the employer's business premises, or provided on or near the employer's business premises through an employer-operated facility that meets certain requirements.
Accounting Method Modifications
There are a number of accounting method changes that have been expanded and may provide valuable tools to defer income for certain taxpayers. Among these changes are changes to:
- Accounting for Inventory
- The Cash Method of Accounting
- Taxable year of Inclusion
- Accounting for Long-Term Contracts
- Capitalization and Inclusion of certain Expenses in Inventory Costs
These are only the highlights. Hopefully, these items encourage you to plan for the impact this monumental tax law change today and in the future.
Please reach out to your Herbein+Company, Inc. contact person to discuss these opportunities further.
This article was compiled by Chuck Bezler, to read more about Chuck click here.