By Greg Banner
The Tax Cuts and Jobs Act was the center of attention in Washington last fall, being signed into law by the President on December 22, 2017. However, between the 500 or so page bill and the 600 page conference report that explained it, (1) most people never actually took the time to read it in its entirety. The internet hosts a plethora of articles giving a broad explanation of the changes it entails, but many lack the details that actually matter.
We took the time to dig into the details so that we can share them with you. Here are the changes that affect businesses and some tax planning opportunities that they have created.
For S Corporations And Other K-1 Entities
New 20% Deduction (2)
The big change for S corporations and other pass-through entities, which has received a lot of attention, is the new Code 199A deduction for qualified business income (QBI). Many business owners who do not pay corporate income taxes are now allowed to deduct 20% of their business income.
Not every business is eligible for the 20% deduction, though. To determine your company’s eligibility, you must first know if it is a “specified service business.” That is defined as anything that relies primarily on its reputation for its business. Professionals, such as lawyers, doctors, accountants and consultants (but not architects or engineers), are considered to have specified service businesses.
The deduction is allowed in full for singles with taxable income under $157,000 or married filers earning under $315,000. If your taxable income exceeds those amounts but is below $207,500 and $415,000, respectively, you will receive a prorated deduction. If your taxable income exceeds those phase-out limits and is a specified service business, you are not eligible for the 20% deduction.
If you don’t own a specified service business and your taxable income exceeds the phaseout limits above, then “wage limitations” will cap the initial 20% deduction amount. The “wage limitation” is the greater of either 50% of wages paid or 25% of wages paid plus 2.5% of capital. Qualified property for the 2.5% of capital includes “tangible property of a character subject to depreciation” and for which the depreciable period has not ended before the close of the taxable year. Sold property does not count, but all 3-, 5-, and 7-year assets will be taken into account for 10 years.
The 20% deduction is taken on QBI, which applies to K-1 Box 1, trade or business income. QBI does not include wages paid or other guaranteed payments. The deduction provides a reduction in taxable income but does not reduce gross income. Because of this, it will not affect deductions based on adjusted gross income (AGI) limitations.
For C Corporations (3)
Rates & Alternative Minimum Tax
The alternative minimum tax for C corporations was completely eliminated after the 2017 tax year. Beginning in 2018, the normal rates have changed as well. The various brackets that went up to 39% have been replaced with a 21% flat corporate tax rate.
It seems that this might tempt the K-1 entities mentioned above to become C corporations, especially those ineligible for the Code 199A 20% deduction. But, when a C corporation pays out its profits in wages, it could face a marginal rate of up to 37% (let alone 2.9% in employment taxes for closely held companies). This negates any apparent benefits of changing entities.
Section 1202 Qualified Small Business Stock (4)
While the new 20% deduction adopts some of its language in restricting specified service businesses from Section 1202, they are not related. The Tax Cuts and Jobs Act does not make any changes to Section 1202. Taxpayers can still exclude 100% of the gain on up to $10 million of qualified small business stock issued after September 27, 2010, if they have held it for more than five years. If they have held it less than five years, they must roll the gain into a new qualified small business within 60 days.
Depreciation
All business assets, whether commercial property or computers, have traditionally been depreciated over time on schedules set by the tax code. Only Section 179 allows a business to take full depreciation in the first year, but it only applies to certain assets.
Under the new law, a corporation can elect to either take 100% depreciation on an asset or spread out depreciation as done before. This bonus appreciation can only be taken on qualified property acquired and placed in service on or after September 27, 2017. Such qualified property includes productions and plants bearing fruit or nuts since the “original use” rule has been eliminated as well. Also included as Section 179 property are HVAC units placed in service after November 2, 2017. This bonus depreciation provides a great tax planning opportunity for businesses.
It also greatly benefits people who like to drive nice cars. The IRS has increased the luxury car cap from $3,160 to $10,000. Coupled with the additional bonus depreciation, up to an $18,000 depreciation deduction can be taken in 2018.
In addition, $1 million of Section 179 property may be immediately expensed beginning in 2018, with a phase-out threshold up to $2.5 million. These limits were increased from $520,000 and $2.07 million respectively. When making use of this bonus depreciation, you must remember that 1250 recapture will apply to an asset that is sold at a gain.
The Modified Accelerated Cost Recovery System (MACRS) tax depreciation system has been changed for mixed commercial and residential space. If over 20% of the proceeds come from business, it is depreciated over 39 years. If less than 20% of the proceeds come from business, it uses a 27.5-year schedule. Computers and peripheral equipment have also been removed from the LISTED PROPERTY list.
Net Operating Loss
The two-year carryback for net operating losses (NOLs) has been repealed for tax years ending after December 21, 2017, with the exception of farming NOLs. Instead, NOLs can be carried forward indefinitely. The NOL deduction is limited to 80% of taxable income.
Family Benefits
The new tax law also repealed the employer-provided child care credit. Corporations that provide childcare or daycare will no longer be able to receive a credit for doing so.
However, there is a new credit available to employers who pay for family and medical leave. For wages paid after January 1, 2018, you get a credit of 12.5% of the amount of wages paid to “qualifying employees” during any period in which such employees are on Family and Medical Leave Act (FMLA) leave if the rate of payment is 50% of the employee’s normal wages. Credit is increased by 0.25% (not to exceed 25% total) for each percentage point by which the rate of payment exceeds 50%. This credit was designed to assist employers in retaining employees even while out on leave.
Other Changes
A number of employee benefit deductions were also eliminated. Transportation fringe benefits are gone, such as paying for employee parking passes for the company building’s garage. Meals and entertainment have also been eliminated, meaning you can’t take a deduction for providing free meals in your employee cafeteria. In 2018, only a 50% deduction will be allowed for expenses for food or beverages and to qualifying business meals.
Like-kind exchanges are now only allowed for real property and not tangible personal property, effective December 31, 2017. That means that you can’t exchange a collection of vintage comic books for a wine collection, it has to be real estate property.
There are also changes for carried interest. It now requires a 3-year holding period to be considered a long-term capital gain.
Also new this year, the cash method of accounting can be used by any taxpayer whose gross receipts do not exceed $25 million. Those with gross receipts over $25 million must still use the accrual method. To determine eligibility, receipts cannot exceed $25 million per year for the three prior tax years.
All businesses making more than $25 million in gross receipts are also subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income. This disallowed amount can be carried forward indefinitely.
The dividends received deduction has been increased to allow corporations to save more. The deduction goes from 70% to 50% for subsidiaries where less than 20% is owned, and from 80% to 65% for subsidiaries where less than 80% is owned.
With so many changes made to the Internal Revenue Code, it is important to work with a professional in order to maximize these new opportunities. At Asset Preservation Strategies, we can help identify potential opportunities for your business and the tax planning opportunities to consider. Call us at (858) 455-1825 or click here to set up an appointment today.
About Greg
Gregory Banner is the Vice-President of Asset Preservation Strategies, Inc. and a CERTIFIED FINANCIAL PLANNER™ professional with over 30 years of experience in the financial industry. He specializes in working collaboratively with his clients and their advisors, providing comprehensive planning services such as family office services, business growth strategies, business exit strategies, asset management, retirement planning, tax reduction strategies, insurance and estate planning strategies, and asset protection for both individuals and businesses. A native of San Diego, Greg believes strongly in the benefits of a collaborative network and is a great resource for both clients and professionals. Learn more about Greg by connecting with him on LinkedIn or visiting www.asset-preservation.com.
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(2) https://www.jdsupra.com/legalnews/new-internal-revenue-code-section-199a-88161/
(3) https://www.bdo.com/insights/tax/federal-tax/corporate-tax-reform-summary-of-new-laws