By: Lucas Rihely
The recently enacted Tax Cuts and Jobs Act (“TCJA”) is perhaps the most sweeping change to the federal tax code in three decades with many of its changes affecting businesses. The purpose of this blog article is to provide an overview of some of the changes that will be affecting a vast number of businesses. Unless otherwise noted, these changes are effective for tax years beginning after December 31, 2017.
- Corporate tax rates reduced – The tax rate for corporations (C Corporations, in this case, to differentiate from S Corporations) has been reduced to a flat 21%. Prior to the TCJA, the rates were graduated with the highest marginal rate being 35%. This change in rate to the flat 21% also applies to professional service corporations that were previously taxed at a flat 35% rather than under the gradual rate tax brackets.
- Qualified Business Income Deduction for Pass-Through Entities: Newly created by the TCJA, the Qualified Business Income Deduction (“QBI Deduction” or “QBID”) is a deduction generally equal to 20% of a taxpayer’s qualified business income from a partnership, S corporation, or sole proprietorship. Certain limitations, such as factors on wages paid or property owned, are placed into effect when taxpayers exceed income thresholds of $157,500 ($315,000 for married filing jointly). For taxpayers in certain professional services, such as health care, law, and accounting, the deduction begins phasing out at the aforementioned income thresholds and may ultimately become completely phased out. This deduction is perhaps the most significant change in the tax law.
- Net Operating Loss (NOL) deduction modified – Generally, NOLs arising in tax years ending after 2017 can only be carried forward, not back, and these losses are able to be carried forward indefinitely. Under pre-TCJA law, the NOLs were subject to a 2-year carryback, 20-year carryforward provision in which any unused NOL after 20 years expires. Also under the TJCA, for losses arising in tax years beginning after 2017, the NOL deduction is limited to 80% of taxable income, calculated without regard to the deduction.
- Expanded use of the cash method of accounting – The TCJA has widened the availability of the cash method of accounting, increasing the gross receipts threshold to include taxpayers whose annual gross receipts are not in excess of $25 million using the average of the previous three years. Taxpayers permitted to make use of this increased threshold include taxpayers to whom inventory is a material income-producing factor. Further, changes have been made to inventory accounting and cost capitalization requirements in light of these new rules.
- Limit on business interest deduction – This new limitation applies to taxpayers with average annual gross receipts in excess of $25 million. This average is calculated over the three-year period ending with the prior tax year. Those taxpayers not exempt from the limitation will see its deduction for business interest limited to 30% of its adjusted taxable income. The limitation is calculated at the entity-level. Any business interest disallowed under this rule is carried into the following year and may generally be carried forward indefinitely.
- Increased Code Sec. 179 expensing – The maximum amount that may be expensed under Sec. 179 is increased to $1 million. If more than $2.5 million of property is placed in service during the year, the $1 million limitation is reduced by the excess over $2.5 million. The expense election has been expanded to cover certain property placed into service in connection with furnishing lodging. Additionally, certain types of improvements to nonresidential real property now qualify, such as: roofing, HVAC, and certain improvements that do not enlarge the building and are not structural in nature.
- Bonus depreciation – Under the new law, a 100% first-year deduction is allowed for qualified property acquired and placed into service after September 27, 2017 and before 2023. The pre-TCJA law provided for a 50% allowance on new Under the new law, the type of property has been expanded as well to include used property.
- Luxury auto depreciation limits – Under the new law, for a passenger automobile which falls under the luxury auto definition and bonus depreciation is not claimed, the maximum depreciation allowance is increased to $10,000 for the year it’s placed in service, $16,000 for the second year, $9,000 for the third year, and $5,760 for the fourth and later years. The maximum first year bonus depreciation allowance remains at $8,000.
- Like-kind exchange treatment limited – Under TJCA, the use of like-kind exchanges, a technique used to defer a gain on the sale of property, is limited to cover only like-kind exchanges of real property not primarily held for sale. The previous law permitted this technique to be used for like-kind exchanges of personal property as well.
- Alternative minimum tax – The corporate alternative minimum tax (“AMT”) has been repealed by the new law.
- Domestic production activities deduction (“DPAD”) repealed – The TJCA repeals the DPAD which allowed a 9% deduction for certain domestic activities of, generally, manufacturers, producers, growers, and extractors.
Please check back regularly for additional content related to this sweeping change in tax law. If you have questions on how this information affects your business specifically, or how you can best position your business in light of the new tax law, please contact us today to schedule an appointment