On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (H.R. 1), which makes sweeping changes to the U.S. tax code and impacts almost every type of taxpayer. For businesses, tax benefits include a reduction in the corporate tax rate, increase in the bonus depreciation allowance, an enhancement to the Code Section 179 expense and repeal of the alternative minimum tax. It is important to note new changes impacting “pass-through” entities, and elimination of certain business tax preferences. The following are highlights of pertinent changes in the tax code for businesses to be aware of.
Corporate Taxes – C Corporations
The corporate tax rate is permanently reduced to 21 percent, beginning in 2018. Previously, the maximum corporate tax rate was 35 percent. Under the new law, the previous 80-percent and 70-percent dividends received deductions are reduced to 65-percent and 50-percent respectively. H.R. 1 also repeals the alternative minimum tax on corporations.
Deductions and Credits
Business tax preferences such as Code Section 199 domestic production activities deduction, non-real property like-kind exchanges, and more are eliminated. Rules for deductions such as business meals and credits for rehabilitation are revised. The research and development credit now requires five-year amortization of research and development expenditures. Businesses should also note a temporary credit for employers paying employees who are on family and medical leave.
Pass-Through Businesses
Under the previous tax law, owners of partnerships, S corporations, and sole proprietorships (pass-through entities) – paid tax on the pass-through income at their individual rates. H.R. 1 allows a temporary deduction in an amount equal to 20 percent of qualified income of these pass-through entities, subject to limitations and qualifications. H.R. 1 also limits the deduction for excess business losses from pass-through entities.
Pass-through Income Deduction
Noncorporate taxpayers may deduct up to 20 percent of domestic qualified business income from a partnership, S corporation, or sole proprietorship, applying to tax years from 2018 through 2025. A limitation on this deduction is phased in for taxpayers with taxable income above a $315,000 married filing joint and $207,500 for all other taxpayers. The limitation is based on wages paid or on wages paid plus a capital element. There are additional limitations that apply for certain service trades or businesses.The deduction amount cannot be more than the taxpayer’s taxable income (reduced by net capital gain) for the tax year.
Limit on Excess Business Losses for Noncorporate Taxpayers
Under the new law, excess business losses of noncorporate taxpayers are not allowed for tax years beginning after December 31, 2017 and before January 1, 2026. Any excess business loss that is disallowed is treated as part of the taxpayer’s net operating loss (NOL) carryover to the following tax year. This rule for excess business losses applies to noncorporate taxpayers after applying the passive activity loss rules. For partnerships and S corporations, the limit on excess business losses is applied at the partner or shareholder level. The result of this provision is that an individual taxpayer is limited to offsetting a maximum of $250,000 of business loss against other income for the tax year. For losses arising in tax years beginning after December 31, 2017, the NOL can be no longer be carried back, but can be carried forward indefinitely, with a few exceptions. In addition, the NOL deduction may only reduce 80 percent of taxable income in a carryforward tax year.
Section 179 Expensing
H.R. 1 enhances Code Section 179 expensing with the new dollar limitation set at $1 million, and the investment limitation at $2.5 million. It also allows for a taxpayer to elect to expense only particular qualifying assets within any asset class.
Bonus Depreciation
The bonus depreciation rate is often utilized as an incentive for business growth and job creation. This rate has fluctuated dramatically over the last 15 years, from zero percent to 100 percent. H.R. 1 temporarily increases the 50 percent bonus depreciation allowance to 100 percent, for property placed in service after September 27, 2017 and before January 1, 2023. The new law also no longer requires the original use of qualified property to commence with the taxpayer, thus allowing bonus depreciation on the purchase of used property.
Interest Deductions
The deduction for net interest expense is now capped at 30 percent of adjusted taxable income under the new tax law. There are, however, exceptions for small businesses, including an exemption for businesses with average gross receipts of $25 million or less.
These are highlights of the changes for businesses to note within the Tax Cuts and Jobs Act. Businesses will have to maintain a proactive stance regarding the new changes coming into effect for the 2018 tax year. To contact someone at our firm regarding concerns from the above information, click here.
