Most U.S. businesses will receive a big tax cut starting with their 2018 tax years, thanks to the new law that was enacted on December 22. But some industries (such as retail, hospitality and banking) generally expect to reap more benefits than others (such as certain professional practices).
The provisions in the law — known as the Tax Cuts and Jobs Act (TCJA) — are generally effective for tax years beginning after December 31, 2017 (except where noted otherwise). And, unlike the provisions for individual taxpayers, many of these provisions are permanent.
Here’s an overview of some of the changes that affect businesses.
Corporate Tax Cut
Under prior law, C corporations paid graduated federal income tax rates of 15%, 25%, 34% and 35% on taxable income over $10 million. Personal service corporations (PSCs) paid a flat 35% rate.
For tax years beginning after December 31, 2017, the TCJA establishes a flat 21% corporate rate. That reduced rate also applies to PSCs.
Elimination of Corporate Alternative Minimum Tax (AMT)
Under prior law, the corporate AMT was imposed at a 20% rate. However, corporations with average annual gross receipts of less than $7.5 million for the preceding three tax years were exempt. For tax years beginning after December 31, 2017, the TCJA repeals the corporate AMT.
Capital Asset Expensing and Depreciation Provisions
In general, businesses will be able to deduct more for capital expenditures in the first year they’re placed in service, and in some cases depreciate any remaining amounts over shorter time periods. Two key tax breaks allow for accelerated expensing:
1. Expanded Section 179 deductions.Under the TCJA, for qualifying property placed in service in tax years beginning after December 31, 2017, the maximum Sec. 179 deduction increases to $1 million (up from $510,000 for tax years beginning in 2017) and the Sec. 179 deduction phaseout threshold increases to $2.5 million (up from $2.03 million for tax years beginning in 2017).
The TCJA also expands the definition of eligible property to include certain depreciable tangible personal property used predominantly to furnish lodging. The definition of qualified real property eligible for the Sec. 179 deduction is also expanded to include qualified expenditures for roofs, HVAC equipment, fire protection and alarm systems, and security systems for nonresidential real property.
2. More generous first-year bonus depreciation. Under the TCJA, for qualified property placed in service between September 28, 2017, and December 31, 2022 (or by December 31, 2023, for certain property with longer production periods), the first-year bonus depreciation percentage is increased to 100% (up from 50% in 2017). The 100% deduction is allowed for both new and used qualifying property.
In later years, the first-year bonus depreciation deduction is scheduled to be reduced as follows:
- 80% for property placed in service in calendar year 2023,
- 60% for property placed in service in calendar year 2024,
- 40% for property placed in service in calendar year 2025, and
- 20% for property placed in service in calendar year 2026.
Important note: For certain property with longer production periods, the preceding cutbacks are delayed by one year. For example, the 80% deduction rate will apply to property with long production periods that are placed in service in 2024.
Deductions for Passenger Vehicles Used for Business
For new or used passenger vehicles that are placed in service after December 31, 2017, and used over 50% for business, the maximum annual depreciation deductions allowed under the TCJA are:
- $10,000 for the first year,
- $16,000 for the second year,
- $9,600 for the third year, and
- $5,760 for the fourth and subsequent years until the vehicle is fully depreciated.
For 2017, the limits under the prior law for passenger cars are:
- $11,160 for the first year for a new car or $3,160 for a used car,
- $5,100 for the second year,
- $3,050 for the third year, and
- $1,875 for the fourth and subsequent years.
Slightly higher limits apply to light trucks and light vans.
Limits on Business Interest Deductions
Prior law generally allowed full deductions for interest paid or accrued by a business (subject to some restrictions and exceptions). Under the TCJA, affected corporate and noncorporate businesses generally can’t deduct interest expense in excess of 30% of “adjusted taxable income,” starting with tax years beginning after December 31, 2017.
For S corporations, partnerships, and LLCs that are treated as partnerships for tax purposes, this limit applies at the entity level, rather than at the owner level.
For tax years beginning in 2018 through 2021, you must calculate adjusted taxable income by adding back allowable deductions for depreciation, amortization and depletion. After 2021, these amounts aren’t added back when calculating adjusted taxable income.
Business interest expense that’s disallowed under this limitation is treated as business interest arising in the following taxable year. Amounts that can’t be deducted in the current year can generally be carried forward indefinitely.
Important note: Some taxpayers are exempt from the interest deduction limitation, including:
- Taxpayers (other than tax shelters) with average annual gross receipts of $25 million or less for the three previous tax years,
- Real property businesses that elect to use a slower depreciation method for their real property, and
- Farming businesses that elect to use a slower depreciation method for farming property with a normal depreciation period of 10 years or longer.
Another exemption applies to interest expense from dealer floor plan financing. For example, this exemption applies to dealers that finance purchases or leases of motor vehicles, boats or farm machinery.
Deductions for Business Entertainment and Certain Employee Fringe Benefits
Under prior law, taxpayers could generally deduct 50% of expenses for business-related meals and entertainment. Meals provided to an employee for the convenience of the employer on the employer’s business premises were 100% deductible by the employer and tax-free to the recipient employee. Various other employer-provided fringe benefits were also deductible by the employer and tax-free to the recipient employee.
Under the TCJA, deductions for business-related entertainment expenses are completely disallowed for amounts paid or incurred after December 31, 2017. Though meals purchased while traveling on business are still 50% deductible, the 50% disallowance rule also now applies to meals provided via an on-premises cafeteria or otherwise on the employer’s premises for the convenience of the employer. After 2025, the cost of meals provided through an on-premises cafeteria or otherwise on the employer’s premises won’t be deductible.
In addition, the TCJA disallows employer deductions for the cost of providing commuting transportation to an employee (such as hiring a car service), unless the transportation is necessary for the employee’s safety. And the new law eliminates deductions by employers for the cost of providing qualified employee transportation fringe benefits (for example, parking allowances, mass transit passes, and van pooling). However, those benefits are still tax-free to recipient employees.
Foreign Tax Provisions
The TCJA includes many changes that will affect business taxpayers with foreign operations. In conjunction with the new 21% corporate tax rate, these changes are intended to encourage multinational companies to conduct more operations in the U.S., with the resulting increased investments and job creation in this country.
Other noteworthy provisions of the TCJA that might affect your business include:
Cash method accounting. The new law liberalizes the eligibility requirements for electing the more-flexible cash method of accounting, making that method available to many more medium-size businesses. Also, eligible businesses are excused from the chore of doing inventory accounting for tax purposes.
Net operating losses (NOLs). For NOLs that arise in tax years ending after December 31, 2017, the maximum amount of taxable income for a year that can be offset with NOL deductions is generally reduced from 100% to 80%. In addition, NOLs incurred in those years can no longer be carried back to an earlier tax year (except for certain farming losses). Affected NOLs can be carried forward indefinitely.
Excess business losses. A new limitation applies to deductions for “excess business losses” incurred by noncorporate taxpayers. Losses that are disallowed under this rule are carried forward to later tax years, and then they can be deducted under the rules that apply to NOLs. This new limitation applies after applying the passive activity loss rules. However, it only applies to an individual taxpayer if the excess business loss exceeds the applicable threshold.
Like-kind exchanges. The Section 1031 rules that allow tax-deferred exchanges of appreciated like-kind property are allowed for only real estate for exchanges completed after December 31, 2017. Under the TCJA, like-kind exchanges of personal property assets aren’t permitted. However, prior law applies if one leg of an exchange was completed as of December 31, 2017, but another leg of the exchange remained open on that date.
Officers’ compensation. Deductions for compensation paid to principal executive officers generally can’t exceed $1 million a year. A transition rule applies to amounts paid under binding contracts that were in effect as of November 2, 2017.
R&D expenses. Under prior law, eligible research and development expenses can be deducted in the current period. Starting with tax years beginning after December 31, 2021, specified R&D expenses must be capitalized and amortized over five years, or 15 years if the R&D is conducted outside the U.S.
Rehab credits. For amounts paid or incurred after December 31, 2017, the TCJA repeals the 10% rehabilitation credit for expenditures on pre-1936 buildings. The new law continues the 20% credit for qualified expenditures on certified historic structures, but the credit must be spread over five years. Certain transition rules apply.
Domestic production activities deduction (DPAD). The DPAD, which could be up to 9% of eligible income, is eliminated for tax years beginning after December 31, 2017.
Lobbying expenses. The deduction for local lobbying expenses is eliminated.
Contact Your Tax Pro
The TCJA is almost 500 pages long and covers a wide range of topics. We’ve summarized only the highlights here. For more detailed information, contact your tax advisor for insight into how the changes will impact your specific business.
Tax Breaks for Pass-Through Businesses
Under prior law, net taxable income from pass-through business entities — including sole proprietorships, S corporations, partnerships and limited liability companies (LLCs) that are treated as sole proprietorships or as partnerships for tax purposes — was simply passed through to owners and taxed at the owners’ rates.
For tax years beginning after December 31, 2017, the new tax law establishes a new deduction based on a noncorporate owner’s share of a pass-through entity’s qualified business income (QBI). This break is available to eligible individuals, estates and trusts. The deduction generally equals 20% of QBI, subject to restrictions that can apply at higher income levels.
The QBI deduction isn’t allowed in calculating the noncorporate owner’s adjusted gross income (AGI), but it reduces taxable income. In effect, it’s treated the same as an allowable itemized deduction.
Limitation on W-2 Wages
For pass-through entities other than sole proprietorships, the QBI deduction generally can’t exceed the greater of the noncorporate owner’s share of:
- 50% of the amount of W-2 wages paid to employees by the qualified business during the tax year, or
- The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property.
“Qualified property” means depreciable tangible property (including real estate) owned by a qualified business as of the tax year end and used by the business at any point during the tax year for the production of QBI.
Under an exception, the W-2 wage limitation doesn’t apply until an individual owner’s taxable income exceeds $157,500 or $315,000 for a married individual who files jointly. Above those income levels, the W-2 wage limitation is phased in over a $50,000 range or over a $100,000 range for married individuals who file jointly.
Limitation on Service Business Income
The QBI deduction generally isn’t available for income from specified service businesses, such as most professional practices. Under an exception, however, the service business limitation does apply until an individual owner’s taxable income exceeds $157,500 or $315,000 for a married individual who files jointly. Above those income levels, the service business limitation is phased in over a $50,000 range or over a $100,000 range for married joint-filers.
Important note: The W-2 wage limitation and the service business limitation don’t apply as long as taxable income is under the applicable threshold. In that case, you should qualify for the full 20% QBI deduction.
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