The “Tax Cuts and Jobs Bill” – Business Tax Provisions
This bill is the largest tax bill since the Tax Reform Act of 1986, which introduced the passive activity loss and many other fundamental rules.
The House and Senate approved the bill on Wednesday, December 20 on a party-line vote and then signed by President Trump on December 22, 2017.
Following are the details of the final conference committee bill, reconciling the Senate and House bills. All effective dates are January 1, 2018, unless otherwise noted. All business provisions are permanent unless otherwise noted.
Business Tax Provisions
Corporate Income Tax
- Current Rule Taxed at graduated rates from 15% to 35%. Personal service corporations (“PSCs”) are taxed at the top marginal rate.
- This Bill Taxed at a flat 21%, beginning in 2018 (not 2019 as proposed by the Senate). PSCs are taxed at the same rate.
Tax Rate on Business Income from Proprietorships, Partnerships, LLCs, and S Corporations
- Current Rule Taxed as ordinary income at marginal tax rates.
- This Bill These owners will get a deduction for 20% of their “qualified business income”. The deduction cannot exceed a wage test amount, but those with taxable income that does not exceed $157,500 single or $315,000 married-filing-jointly are exempt from this test. Effective for tax years 2018 through 2025.
- This wage test is the greater of (1) 50% of the wages paid by the business to its employees, or (2) 25% of the wages paid plus 2.5% of the unadjusted basis of tangible depreciable property in the business.
- Certain businesses face an additional limitation. These businesses are those in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, and any other business where the principal asset of the business is the reputation and skill of one or more of its employees. Engineering and architecture are specifically excluded from this particular definition. These businesses are eligible for the deduction to the extent that taxable income does not exceed $157,500 single or $315,000 married-filing-jointly. The deduction phases out over the next $50,000 for single taxpayers (fully phased out at $207,500) and over the next $100,000 for those married-filing-jointly (fully phased out at $415,000).
- This deduction is a deduction after AGI but before taxable income. Thus it does not reduce AGI for purposes of other AGI-based tests.
- There are many gray areas here that Congress is leaving to the discretion of the IRS to provide clarification and guidance. Expect extensive discussion and illustrations in the coming months.
- Observation One of the most complicated provisions in this bill, and one which will result in much examination of the structure of business operations so as to benefit from this rule.
Section 179 – Depreciation Expensing
- Current Rule
- Can deduct up to $500,000 per year, but it cannot create a loss. Begin to lose the ability to claim the deductions at $2 million of eligible additions in that year.
- The maximum Section 179 on an SUV is $25,000 per vehicle.
- Furnishings and equipment used in a rental are not eligible.
- Some qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property) are eligible for Section 179.
- This Bill
- Deduction increased to up to $1 million, with a phase-out beginning at $2.5 million. These amounts are indexed for inflation after 2018.
- The SUV maximum remains at $25,000 but is indexed for inflation after 2018.
- Rental assets become eligible for Section 179.
- The list of qualified real property for Section 179 is expanded to include the following for nonresidential real property – roofs, HVAC, fire protection systems, and security systems when these items are acquired after the building is placed in service.
- Observation A significant tax incentive for small to medium-sized businesses. Taxpayers should expect that states will not follow this.
Section 168(k) – “Bonus” Depreciation
- Current Rule Can deduct 50% of the cost of certain “new” additions per year, without a maximum cap. Phases down to 40% in 2018, and 30% in 2019, and repealed after 2019.
- This Bill
- Taxpayers can deduct 100% of the cost for acquisitions after 9/27/2017.
- It is no longer required for the property’s use to be “new” to the taxpayer. But the property is ineligible if the taxpayer used it prior to the acquisition (like a lease buyout).
- For the first tax year ending after 9/27/2017 (this is the 2017 calendar year for most of our clients), the taxpayer can elect to stay with the old 50% deduction instead of the 100% deduction. That gives businesses three options for the 9/28/2017 to 12/31/2017 window (100%, 50%, or elect out).
- Bonus depreciation is 100% for acquisitions through 12/31/2022 and is phased out after 2026. Percentages phase down as follows – 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026.
- Observation Another significant tax incentive for all businesses, beginning before Taxpayers should expect that states will not follow this treatment.
Section 280F “Listed” Property Depreciation
- Current Rule Certain passenger automobiles which are subject to personal use are limited for annual depreciation to $3,160 in year 1, $5,100 in year 2, $3,050 in year 3, and $1,875 per year thereafter. This applies to both regular depreciation and Section 179 expensing, plus a maximum of $8,000 for 168(k) depreciation (if the property is eligible under those rules). Special rules also apply to other listed property, such as computer equipment. Listed assets are subject to additional scrutiny for substantiation of business use.
- This Bill
- Removes computers from the definition of listed property.
- Increases the maximum depreciation on listed autos to $10,000 in year 1, $16,000 in year 2, $9,600 in year 3, and $5,760 per year after year 3. These amounts are indexed for inflation after 2018.
Real Estate Depreciation
- Current Rule
- Business real estate is depreciable over straight-line MACRS for 39 years. If the real estate is residential in nature, the life is shortened to 27.5 years.
- Special rules apply to real estate defined as qualified leasehold improvement property, qualified restaurant property, qualified retail improvement property, and qualified improvement property. These categories are depreciated over 15 years and may qualify for accelerated depreciation under Sections 168(k) and 179.
- This Bill
- The concepts of qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property are all eliminated.
- The category of qualified improvement property over 15 years is retained. Restaurant building property that does not meet this standard is depreciable over 25 years.
- An earlier proposal would have reduced the depreciable life of business real estate to 25 years. This provision did not survive into the final bill.
Depreciation of Farming Equipment
- Current Rule Equipment used in farming are generally depreciated over 7 years using 150% MACRS (declining-balance, switching to the straight line) depreciation methods, instead of the 200% used by other businesses.
- This Bill Reduces the depreciable life of farm equipment to 5 years and repeals the requirement to use 150% depreciation (moving to the 200% general rule).
Deduction of Interest Expense
- Current Rule No limit.
- This Bill
- Limits the deduction of business interest to the sum of (1) business interest income, (2) 30% of adjusted taxable income, and (3) floor plan financing interest.
- Any excess interest expense is carried forward for up to five years.
- Adjusted taxable income is taxable income without –
- Any income, gain, deduction, or loss that is not related to the business,
- Any business interest income,
- NOL taken, and
- Deductions for depreciation, amortization, or depletion.
- For flow-through businesses, this test is applied at the entity level, and if the individual also has a business interest limitation, then the flow-through income is not counted a second time at the individual level.
- Businesses with average annual gross receipts of $25 million or less are exempt from this rule.
Small Business Accounting Method Simplification
- Current Rule
- Certain businesses, generally those that maintain inventories, are required to use the accrual method of accounting. A “C” corporation must convert to the accrual method (from the cash method) at $5 million of average annual gross receipts. Other types of entities generally must use the accrual method at $10 million of average annual receipts.
- The Section 263A uniform capitalization rules apply to businesses who resell the property at $10 million of annual gross receipts. Producers of property are subject to these rules if they have more than $200,000 of indirect production costs.
- Businesses are generally required to use the percentage-of-completion method of accounting for long-term contracts. However, if certain tests are met, including average annual gross receipt of $10 million or less, the business can use the completed contract method of accounting.
- This Bill
- Allows the use of the cash method through $25 million of average annual gross receipts. This $25 million threshold amount is indexed for inflation after 2018.
- Any reseller or producer meeting this $25 million test is also exempt from the application of 263A.
- The gross receipts test to continue using the completed contract method of accounting for long-term contracts is increased to $25 million.
- Adoption of any of these provisions is an accounting method change, which presumably would require the filing of a 3115 and the adoption of taking the entire benefit in the first year.
Alternative Minimum Tax
- Current Rule The AMT is imposed on corporations.
- This Bill Completely repeals the AMT on corporate taxpayers. Any existing AMT credit carryover is allowed to offset regular tax liability in tax years 2018 through 2022.
Net Operating Losses (“NOLs”)
- Current Rule Can carry back an NOL for two years, and/or carry forward for up to twenty years.
- This Bill No further carrybacks after 2017 except for those in the business of farming. Carryforwards do not expire but are limited to 80% of income through 2022. Thus, a profitable taxpayer may still be required to pay tax on 20% of the income, even if you have plenty of NOLs.
- Observation It appears that NOLs originating pre-2018 but used post-2017 would continue to be allowed at 100%. Only the NOLs from post-2017 losses are limited to 80%.
Some other specific business tax rules set to change:
- Accounting Methods on Change from “S” Corporation to “C” Corporation Status This bill states that any income from an accounting method change resulting from the revocation of an “S” election is taken into account over six years. This applies to a corporation which converts to “C” status in the two year period beginning on enactment, and only if the owners have not changed.
- Entertainment Deduction Currently generally 50% deductible, now not deductible.
- Like-Kind Exchanges Allowed for real and personal property used for investment or in a business. Under this bill, like-kind gain deferral is repealed for non-real estate property.
- Domestic Production Deduction Currently 9% of production activity income is deductible, now repealed after 2017.
- Local Lobbying Expenses Currently deductible. Deduction repealed with the effective date of enactment.
- Settlements and Restitution
- Currently generally deductible.
- This bill provides that any amount paid at the direction of another entity in relation to the violation of any law, or an investigation or inquiry into the potential violation of any law, is a nondeductible fine. An exemption remains for restitution payments, which is deductible if it would have been deductible at the time it should have been paid. Effective as of the date of enactment.
- If the payment is in connection with a claim of sexual harassment or abuse, and if paid subject to a non-disclosure agreement, then the payment is not deductible. Effect as of the date of enactment.
- Contributions to Capital Under this bill, a nontaxable contribution to capital does not include a payment from a customer or a potential customer, or any contribution by any governmental entity or civic group.
- Technical Termination Rule A partnership (or an entity taxed as a partnership) is considered terminated and a new partnership started where there is a sale or exchange of more than 50% of the ownership interests in a 12-month period. This bill repeals this rule.
Please contact us if you have any questions.