The Tax Cuts and Jobs Act that was passed in December 2017 features the most changes to the U.S. tax code in decades and it will impact nearly every individual and business. For businesses, tax benefits include a reduction in the corporate tax rate, increase in the bonus depreciation allowance, enhancement to the Code Sec. 179 expense, and repeal of the alternative minimum tax. Owners of partnerships, S corporations, and sole proprietorships are allowed a temporary deduction as a percentage of qualified income of pass-through entities, subject to a number of limitations and qualifications. On the other hand, numerous business tax preferences are eliminated.
Corporate Tax Rates Reduced – One of the more significant new law provisions cuts the corporate tax rate to a flat 21%. Before the new law, rates were graduated, starting at 15% for taxable income up to $50,000, with rates at 25% for income between $50,001 and $75,000, 34% for income between $75,001 and $10 million, and 35% for income above $10 million.
Pass-Through Businesses – Prior to the end of 2017, owners of partnerships, S corporations, and sole proprietorships — as “pass-through” entities — paid tax at the individual rates, with the highest rate at 39.6%. The Tax Cuts and Jobs Act allows a temporary deduction in an amount equal to 20% of qualified income of pass-through entities, subject to a number of limitations and qualifications.
The Tax Cuts and Jobs Act contains rules that will prevent pass-through owners — particularly service providers such as accountants, doctors, lawyers, etc. — from converting their compensation income taxed at higher rates into profits taxed at the lower rate.
Bonus Depreciation Increased – The bonus depreciation rate has fluctuated wildly over the last 15 years and is often seen as a means to incentivize business growth and job creation. The Tax Cuts and Jobs Act temporarily increases the 50% “bonus depreciation” allowance to 100%. It also removes the requirement that the original use of qualified property must commence with the taxpayer, thus allowing bonus depreciation on the purchase of used property.
Section 179 Expensing – The Tax Cuts and Jobs Act increases the Code Sec. 179 dollar limitation to $1 million and the investment limitation to $2.5 million. Although the differences between bonus depreciation and Code Sec. 179 expensing would now be narrowed if both offer 100% write-offs for new or used property, some advantages and disadvantages for each will remain. For example, Code Sec. 179 property is subject to recapture if business use of the property during a tax year falls to 50% or less; but Code Sec. 179 allows a taxpayer to elect to expense only particular qualifying assets within any asset class.
Deductions and Credits – Numerous business tax preferences are eliminated, including the Code Sec. 199 domestic production activities deduction, non-real property, like-kind exchanges, and more. Additionally, the rules for business meals and rehabilitation credits are revised. However, the Tax Cuts and Jobs Act leaves the research and development credit in place, but requires five-year amortization of research and development expenditures.
It also creates a temporary credit for employers paying employees who are on family and medical leave. A new general business credit is available for tax years beginning in 2018 and 2019 for eligible employers equal to 12.5% of wages they pay to qualifying employees on family and medical leave if the rate of payment is 50% of wages normally paid to the employee. The credit increases by 0.25% (up to a maximum of 25%) for each percent by which the payment rate exceeds 50% of normal wages.
The Tax Cuts and Jobs Act eliminates the 50% deduction for business-related entertainment expenses. Employers may no longer deduct transportation fringe benefits but employees may still exclude these benefits from income. However, bicycle commuting reimbursements are deductible by the employer and are not excludable by the employee.
Interest Deductions – In an attempt to “level the playing field” between businesses that capitalize through equity and those that borrow, the Tax Cuts and Jobs Act generally caps the deduction for net interest expenses at 30% of adjusted taxable income, among other criteria. Exceptions exist for small businesses, including an exemption for businesses with average gross receipts of $25 million or less.
Net Operating Loss (NOL) – Generally, NOLs will be limited to 80% of taxable income for losses arising in tax years beginning after December 31, 2017. It also denies the carryback for NOLs in most cases while providing for an indefinite carryforward, subject to the percentage limitation.
Employee Compensation and Achievement Awards – Under pre-Act law, a deduction for compensation paid or accrued with respect to a covered employee of a publicly traded corporation is deductible only up to $1 million per year. Exceptions apply for commissions, performance-based pay (including stock options), payments to a qualified retirement plan, and amounts excludable from the employee’s gross income. The new law repealed the exceptions for commissions and performance-based pay. The definition of “covered employee” is revised to include the principal executive officer, principal financial officer, and the three highest-paid officers. An individual who is a covered employee for a tax year beginning after 2016 remains a covered employee for all future years.
An employee achievement award is tax free to the extent the employer can deduct its cost, generally limited to $400 for one employee or $1,600 for a qualified plan award. An employee achievement award is an item of tangible personal property given to an employee in recognition of length of service or a safety achievement and presented as part of a meaningful presentation. The new law defines “tangible personal property” to exclude cash, cash equivalents, gift cards, gift coupons, gift certificates (other than from an employer pre-selected limited list), vacations, meals, lodging, theater or sports tickets, stocks, bonds, or similar items, and other non-tangible personal property.
Depreciation Limits – The new law modified some rules for the depreciation of residential rental buildings and certain building improvements.
For a passenger automobile for which bonus depreciation (see above) 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 in the recovery period. These amounts are indexed for inflation after 2018.
Like-Kind Exchange Treatment – Under the Tax Cuts and Jobs Act, the rule allowing the deferral of gain on like-kind exchanges of property held for productive use in a taxpayer’s trade or business or for investment purposes is limited to cover only like-kind exchanges of real property not held primarily for sale. Under a transition rule, the pre-TCJA law applies to exchanges of personal property if the taxpayer has either disposed of the property given up or obtained the replacement property before 2018.
While this blog post highlights some of the changes and impact of the Tax Cuts and Jobs Act, there is much more to discuss than can be covered in a short post. If you have further questions or need assistance planning for your specific situation, please call your CPA.
For more information on the Tax Cuts and Jobs Act, read our other blogs about it: