Now that the Tax Cuts and Jobs Act has officially been passed, it’s time to start looking at how these changes will affect your business. Below is an overview of what’s in the tax bill and how businesses may be affected by the changes in the coming years.
Reduced Corporate Tax Rate
Previously, a corporation was subject to 15% (for taxable income of $0 – $50,000), 25% (for taxable income of $50,001 – $75,000), 34% (for taxable income of $75,001 – $10,000,000), and 35% (for taxable income over $10,000,000). A personal service corporation was subject to 35%.
Under new tax law, effective January 1, 2018, the corporate tax rate is a flat 21% rate. That means that no matter how much you earn starting in 2018, corporate and personal service corporations are subject to 21% federal tax.
To maximize the after tax benefits, you may consider a carryback of the net operating loss generated 2017 to 2015 and/or 2016 if you have income in those years and you paid more than 21% in taxes.
Alternative Minimum Tax Repealed
Effective January 1, 2018, Corporate Alternative Minimum Tax (AMT) is repealed. However, it continues to allow the prior year minimum tax credit to offset the taxpayer’s regular tax liability for any tax year. The good news is that from 2018 to 2020, the prior year’s minimum tax credit is refundable in an amount equal to 50% of the excess of the credit and 100% refundable beginning in 2021.
Increased Code 179 Expensing (Section 179)
Effective January 1, 2018, the Section 179 deduction limitation is raised to $1 million and the phase-out amount is raised to $2.5 million. The Act also expands the definition of qualified real property eligible for Section 179 expensing. This real property includes roofs, heating, ventilation and air conditioning property, fire protection and alarm systems, and security systems.
Temporary 100% Cost Recovery of Qualifying Business Assets
Previously, a business was allowed 50% bonus depreciation for qualified property. Under the new Act, taxpayers are able to immediately expense 100% of the cost of qualified property acquired and placed in service starting from September 28, 2017 to December 31, 2022. Property qualifies for this deduction when it is the taxpayer’s first use, including new or used property. That means that if you purchase a used qualified property, you are still able to deduct 100% of the cost.
The first year bonus depreciation deduction will phase down from 2023 to 2026 to 20% and sunsets after 2027.
Luxury Automobile Depreciation Limits Increased
Effective January 1, 2018, the Act increases the depreciation limitations for passenger automobiles as follows:
- $10,000 for the year in which the vehicle is placed in service
- $16,000 for the second year
- $9,600 for the third year
- $5,760 for the fourth year and later years in recovery period
Recovery Period for Real Property Shortened
The nonresidential and residential rental real property continue to depreciate over 39 and 27.5 years, respectively. The key change to the recovery period for real property is qualified improvement property. Qualified improvement property that is placed in service after December 31, 2017 is depreciated over 15 years by using the straight-line method. Qualified improvement property is any improvement to an interior portion of a building that is nonresidential real property if that improvement is placed in service after the date that building was placed in service. The qualified improvement property does not include the enlargement of the building, any elevator or escalator, and internal structural framework of the building.
This new law for the qualified improvement property eliminates the separate definitions of qualified leasehold improvement, qualified restaurant and qualified retail improvement. There is no longer need to worry about whether the lease property is placed in service for more than three years after the date the building was first placed in service.
Limits on Deduction of Business Interest
Under previous law, businesses could generally fully deduct interest paid or accrued. Effective January 1, 2018, every business is only allowed to deduct its business interest expense to the sum of:
A. Business interest income
B. 30% of the adjusted taxable income
C. Floor plan financing interest
Beginning in 2018 through 2021, adjusted taxable income will be calculated by adding back allowable deductions for depreciation, amortization and depletion. These amounts will not be added back into the calculation thereafter. This does not apply to taxpayers if their average annual gross receipts for the three prior tax years were less than $25 million. Additionally, real property and farming businesses can elect out if using certain depreciation methods.
The disallowed business interest deduction amount will be carried forward indefinitely.
Modification of Net Operating Loss (NOL) Deduction
Effective January 1, 2018, a business can deduct a net operating loss carryover from previous years only to the extent of 80% of the taxable income in the tax year. The NOLs can be carried forward indefinitely.
The Act repeals carrybacks, however, there is an exception to this repeal. The NOLs of farming businesses or property and casualty insurance companies can carryback losses two years and carry forward 20 years to offset 100% of taxable income in those years.
New Deduction for Pass-Through Income
Effective January 1, 2018, the new law creates a potential 20% deduction for pass-through companies, including partnerships, S corporations, limited liability companies (LLC) and sole proprietors. The deduction is only applicable for qualified business income (QBI) and is not applicable to certain industries, such as health, law and financial services unless taxable income is below $157,500 for single filers and $315,000 for joint filers.
Additional rules apply and vary based on specific circumstances. Please reach out to us with any questions or to learn more about what this deduction may mean for you.
Like-Kind Exchange Treatment Limited
Previously, there was no gain or loss recognized in the exchange of like-kind property (including real property and tangible personal property) held for productive use in the taxpayer’s trade or business, or held for investment purposes.
Effective January 1, 2018, this like-kind exchange treatment only applies to real property that is not held primarily for sale. Therefore, the gain or loss on the exchange of tangible personal property must be included in the taxpayer’s gross income. For transition under the new law, the old rules still apply to like-kind exchange of personal property if the taxpayer either disposed of relinquished property or acquired replacement property on or before December 31, 2017.
Five-Year Write-off of Specified R&E Expenses
Under old tax law, a taxpayer could elect to deduct certain reasonable research or experimentation (R&E) expenses paid or incurred in connection with a trade or business. The taxpayer could forgo immediate deduction of R&E expenses and instead elect to capitalize and amortize those research expenses
Effective January 1, 2022, a taxpayer must capitalize the research expenses and amortize them over a five year period. If the research expenses are conducted outside of the U.S., the taxpayer must capitalize the expenses and amortize them over a 15 year period. The specified R&E expenses that are subject to capitalization include expenses for software development, but exclude land, depreciable property used in connection with the R&E, or mineral exploration expenses.
When a taxpayer retires or disposes of the R&E capitalized expenses, any remaining basis must continue to be amortized over the remaining amortized period.
Employer’s Deduction for Fringe Benefit Expenses Limited
Effective January 1, 2018, expenses related to business entertainment are no longer deductible, including amusement, sporting events and activities, clubs, etc. While previously 100% deductible, employer-operated eating facilities are only 50% deductible through 2025 and will be non-deductible thereafter. Employers can also no longer deduct the cost of providing qualified transportation benefits, such as transit passes, qualified parking and commuter vehicles.
New Credit for Employer-Paid Family and Medical Leave
The new law provides a two year credit to employers who pay family and medical leave (FMLA) to their employees in 2018 and 2019. A business is allowed to claim a general business credit of 12.5% of the wages paid to qualifying employees who are on family and medical leave if the rate of payments is 50% of the wages normally paid to the employees. The credit would be increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of payment exceeds 50%.
To qualify for the credit, full-time employees must be given at least two weeks of annual paid family and medical leave and part-time employees must be given a pro-rata equivalent of leave. The maximum amount of leave available for the credit is 12 weeks.
Cash Method of Accounting
Effective January 1, 2018, a corporation or partnership with a corporate partner may use the cash method of accounting if its average gross receipts for the prior three tax years does not exceed $25 million ($5 million under previous tax law).
If you are currently using the accrual method of accounting because you exceed the old $5 million threshold, you can file for an accounting method change to switch to the cash method of accounting. We recommend consulting with your tax advisor on the tax implications of this change.
Accounting for Inventories
Effective January 1, 2018, a taxpayer that meets the $25 million gross receipts test is not required to account for inventory under Section 471. Instead, it may use an accounting method that either:
- Treats inventories as non-incidental materials and supplies when used or consumed
- Conforms to the taxpayer’s financial accounting treatment of inventories
Capitalization and Inclusion of Certain Expenses in Inventory Costs
In general, the uniform capitalization (UNICAP) rules require certain direct and indirect costs associated with real or tangible personal property to be the basis of the property. Under the old tax law, resellers that had average gross receipts of $10 million or less in the prior three taxable year period were not subject to UNICAP rules.
Effective January 1, 2018, all businesses that have average gross receipts of $25 million or less in the preceding three years are exempt from the UNICAP rules. This exemption applies to both producer and resellers. This new law expands the pool of taxpayers that can accelerate certain operating expenses. If you would like to get the benefits of this exemption, a change in accounting method request must be filed. We recommend consulting your tax advisor on the potential tax effect of this change.
Accounting for Long-Term Contract
A long-term contract is any contract for work that is not completed within a tax year. The taxable income from long-term contracts are generally determined under the percentage-of-completion method.
Effective January 1, 2018, all construction contracts are exempt from using percentage-of-completion method if the business meets the average annual gross receipts test of $25 million and the contract is expected to be completed within two years. In this case, a small construction business is allowed to use the completed contract method. Under this method, a business is not required to report taxable income on a contract until it is complete, even though the payments are received in the previous year. A request for change of accounting method is also required to affect this change.
Other Repealed Provisions
- Domestic production activities deduction (DPAD)
- Deduction for local lobbying expense
- Partnership Technical Termination
Want to learn more about how the Tax Cuts and Jobs Act will affect your business? Our tax experts are here to answer your questions and help assess your particular situation. Contact us at 925.271.8700 or at firstname.lastname@example.org.