In our previous post, we outlined several areas where the federal tax code is changing, thanks to the passage of the Tax Cuts and Jobs Act in late December. While several provisions deal with individuals, as we pointed out in our latest post, the new tax law contains a myriad of changes for businesses as well. Owners of pass-through entities, like sole proprietorships, LLCs, and S-Corps, are most affected. Read on to learn how.
Tax Reform for Businesses: The Basics
To start with, the new corporate tax rate is capped at 21 percent. This is a huge reduction in corporate taxes that were previously set at a top rate of 35 percent. This brings the U.S. more in line with major trading partners and removes the incentive to accumulate assets. Also, the alternative minimum tax for corporations was repealed. Applicable businesses can take a refundable credit for each tax year beginning in 2018 through 2020 equal to 50 percent of any unused AMT credit carryover. Any additional unused AMT credit in 2021 is 100 percent refundable.
Two popular areas where businesses save money have been modified and extended: bonus depreciation and Section 179 expensing. Bonus depreciation is now available through 2026, with phaseouts beginning in 2023. Bonus depreciation is now also available for existing property, marking a change from previous policy. Section 179 expensing limits also increased to $1 million with a $2.5 million phaseout threshold. Items available for Sec. 179 are expanded to include certain tangible personal property associated with furnishing lodging, as well as nonresidential real property improvements to roofs, HVAC, fire protection and alarms, and security systems. These two changes provide a semi-permanent solution for businesses to make rapid write-offs to capital expenditures.
The last major change is that owners of pass-through entities will have a lower overall tax burden, which is welcome news for the estimated [number] million of small business owners in the U.S.
20 Percent Deduction for Qualifying Income
The Tax Cuts and Jobs Act created a new 20 percent deduction for taxpayers who have income from partnerships, S Corporations, sole proprietorships, trusts, and estates. Qualified income includes:
- Qualified business income
- Qualified cooperative dividends
- Qualified REIT dividends
- Qualified Publicly-Traded partnership income
Qualified business income does not include dividends, investment interest income, short-term capital gains, long-term capital gains, income from annuities, commodities gains, or foreign currency gains. For service businesses like health, law, accounting, actuarial science, consulting, financial services, or any business where an employee’s reputation is the primary asset, the amount of income applicable to the 20 percent deduction cannot exceed $415,000 (married filing jointly) or $207,500 (single). Income phaseouts begin at $315,000 and $157,500, respectively.
As with individual taxes, businesses can no longer count on some of the same deductions they’ve been used to. Entertainment deductions have been repealed, and that includes activities considered amusement or recreation. Membership dues deductions are also gone, and businesses can no longer claim deductions for facility use for any of the above noted items. And, employers can now only deduct 50 percent of meals provided to employees while at work, instead of 100 percent.
However, it is important to note that the existing 50 percent deduction for food and beverage is still in effect. So, make sure to keep your restaurant receipts when you or your employees are traveling for work.
The cash accounting method can now be used for businesses with gross receipts up to $25 million. This is increased from the previous limit of $5 million, and should give more small businesses – and growing businesses – the option of simplified accounting and inventory control. Businesses under the $25 million threshold are also exempt from new business interest deduction limitations.
Like-kind exchanges are now only allowed regarding real property held in business or for investment. And finally, net operating losses in 2018 and future years cannot offset more than 80 percent of taxable income before the NOL deduction. Businesses are also prohibited from carrying the NOL deduction back to previous years, except for certain farming business and property/casualty insurance companies, which can carry NOLs back up to two tax years.
Making any changes to your business tax strategy requires careful thought and planning. While your taxes for 2017 aren’t affected, when you talk with your tax advisor this tax season, be sure to ask about changes to your approach in planning going forward. Please contact our Tax Team with any questions.