Congress Passes Federal Tax Legislation: Business Provisions
December 22, 2017
On December 20, Congress passed the Tax Cuts and Jobs Act, and President Trump signed it into law on December 22. The bill represents the most significant Federal tax law changes since The Tax Reform Act of 1986.
The final bill that came out of a joint Conference Committee represents a compromise of provisions proposed by the House and Senate, and it changes many long-standing and significant rules governing individual and business taxes. In addition, North Carolina and many other states have built their tax laws on the Internal Revenue Code. With such major changes to Federal law, many states will be taking a close look at the implications on their budgets, and we can expect to see some adjustments to state tax laws as a result.
The IRS is responsible for issuing Regulations to clarify and expound on tax legislation after it is enacted. While we expect significant Regulations will be necessary, it could take many months and even years for them to be completed.
Following are highlights of some of the more significant provisions of the Tax Cuts and Jobs Act. Unless otherwise noted, the effective date for all provisions is January 1, 2018.
A summary of individual tax provisions is available at https://www.jpspa.com/congress-passes-federal-tax-reform-legislation/.
Business tax provisions
Most of the following business tax provisions are not set to expire.
Corporate tax rates, AMT, and other changes
Taxpaying corporations (generally referred to as “C corporations”, as opposed to “S corporations”) will see many changes because of this legislation.
Currently, these corporations are subject to rates ranging from 15% to 35% and must contend with AMT. The new law moves to a flat rate of 21% and repeals the AMT. Lowering the top rate should result in lower tax for the most profitable corporations, but corporations with smaller profits could wind up paying more tax.
Personal service corporations (those whose primary income is from services in the fields of health, law, engineering, architecture, accounting, consulting, actuarial science and performing arts), which are currently taxed at a flat rate of 35%, will also be subject to the new 21% rate.
In addition, after 2017 net operating losses (NOLs) cannot be carried back. NOLs will be carried forward indefinitely, but they can only reduce taxable income by 80%.
Tax rates for other businesses
Other businesses such as sole proprietorships, partnerships and S corporations (often referred to as pass-through entities or PTEs) are currently taxed at their owner’s tax rate since this income is reported on the owner’s tax return.
The new law allows a business owner of a PTE to deduct up to 20% of “qualified business income”, with only the balance being subject to tax. Effectively, up to 20% of profits would be tax-free, resulting in a lower overall tax rate for business owners. This deduction may be reduced below 20% for higher-income taxpayers, depending on factors such as employee compensation and investment in business assets.
As noted above, only “qualified business income” (QBI) is eligible for this deduction. QBI excludes income from the following service businesses:
- Health;
- Law;
- Accounting;
- Actuarial science;
- Performing arts;
- Consulting;
- Athletics;
- Financial services; and
- Brokerage activities.
Note that this exclusion for service businesses does not apply if the taxpayer’s total taxable income is below certain thresholds ($315,000 for married filing joint taxpayers). Above those thresholds, the deduction is phased out.
Also, note that income from engineering and architecture services are not excluded (i.e. income from those services can qualify for the deduction).
In addition, income from the following sources is also excluded:
- Investment income such as capital gains, ordinary dividends and interest income;
- Shareholder compensation;
- Guaranteed payments to partners;
- REIT or cooperative dividends; or
- Income from publicly traded partnerships.
Also, if the total QBI is less than zero (e.g. a business incurs a loss), then that amount must be carried over and will reduce QBI in future years. There are many additional complexities to consider, as this is one of the more complex provisions of this legislation.
Section 179 expensing
Businesses have long benefitted from Section 179 expensing, which currently allows assets totaling up to $510,000 to be expensed in the year the asset is placed in service. The deduction is reduced when a business invests more than $2.01 million in a given year.
The new law increases the expense to $1 million and the investment limitation goes up to $2.5 million. In addition, more building improvements will be eligible for Section 179 expensing under the new law, including some assets used in lodging businesses, and assets used in rental operations may also qualify.
Bonus depreciation
Currently businesses can also claim bonus depreciation, allowing them to expense 50% of a qualifying asset’s cost in the initial year and claim regular depreciation on the balance. Qualifying assets are currently required to be new.
Effective for property that is acquired and placed in service after September 27, 2017, the new law increases bonus depreciation to 100% through 2022, and it also allows previously used assets to qualify. After 2023, the percentage will drop until it is eliminated in 2027. The 2017 effective date means that there is a benefit available for the 2017 calendar tax year, but there are a few restrictions. The significant expansion of bonus depreciation could eliminate the need for businesses to claim Section 179, though the eligibility requirements for each still differ.
Other depreciation changes
In addition to expanding Section 179 and bonus depreciation, several other changes (mostly positive for businesses) were made, including:
- Significant increases to annual depreciation limits on vehicles;
- Additional real estate improvements may be eligible for a 15-year life (vs current life of 27.5 or 39 years). These include roofs, HVAC units, fire protection, alarm and security systems.
- Some enhanced opportunities for leasehold improvements, restaurant, and retail real property were removed, partially due to enhancements made via other provisions.
- Most new farming equipment will be eligible for depreciation over a shorter life and more accelerated method.
Domestic production activities deduction (DPAD)
For more than 10 years, businesses that are considered “producers” (e.g. farmers, manufacturing and construction contractors) were permitted to claim this deduction without having to make an associated expenditure. The deduction amounts to 9% of taxable income, subject to various limitations.
The new law repeals this deduction effective in 2018 for most businesses and effective 2019 for C corporations.
Interest deduction limitation
The new law repeals some of the current limitations on the interest deduction and introduces some new ones. Under the new rule, only interest that exceeds the sum of the following three items can be deducted, with the rest being carried over for up to five years:
- Interest income;
- 30% of adjusted taxable income; and
- For automobile and other dealers, any interest on floor plan financing.
This limitation does not apply to businesses with average annual gross receipts of $25 million or less. Upon election, it also would not apply to many real property and farming businesses.
Accounting methods
Businesses are currently required to use certain accounting methods for tax purposes based on their industry, size and other factors. These requirements cover overall accounting methods like accrual and cash basis of accounting, as well as more specific methods.
The new law increases the dollar thresholds that trigger the required use of the accrual method of accounting, inventory capitalization under Section 263A and the percentage-of-completion method for long-term contracts. Generally, businesses with annual gross receipts that do not exceed $25 million will be allowed to use the cash method of accounting. Businesses that meet this gross receipts test will also be exempt from the inventory capitalization provisions of Section 263A. Further, construction contractors meeting the gross receipts test will not be required to use the percentage-of-completion method of accounting for long-term construction contracts.
Qualified personal service businesses are allowed to use the cash basis method of accounting without regard to the gross receipts test.
Other provisions
The new law has numerous other provisions not addressed in this article, including various provisions impacting businesses with foreign ownership or activities, elimination of certain entertainment expense deductions, changes affecting tax-exempt organizations, the repeal of and changes to various partnership tax provisions and a new credit for paying employees while on family or medical leave.
Summary
There are many other provisions of this new legislation that are not included in this article. Also, as there are many complexities in the legislation and the IRS has not yet issued Regulations to clarify some matters, it is important to ensure full understanding of the rules and implications before action is taken. JPS is available to help you understand and consider action items to take in light of your specific situation and facts.
Please continue to watch for more information from JPS about this tax legislation in the coming weeks.
JPS is available to help you understand and consider action items
to take in light of your specific situation and facts. Contact us.
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