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2018 Tax Changes (TCJA), Part II, Business Impact

 

This article is a summary of some of the business changes we feel will impact our clients the most.  It is not intended to discuss all of the changes that occurred under this tax reform act.

Highlights:

  1. Virtually all taxpayers are impacted by the changes
  2. In general, changes take effect on January 1, 2018 and run through 2025.  Some provisional changes have shorter life spans.  For those running through 2025, unless the provision is extended for tax year 2026, these provisions will revert to the rules in effect for tax year 2017.
  3. Going forward, some of these provisions may be modified or made permanent

 


 

Corporate Tax Rate:

  • For C corporations the tax rates have been changed to a flat rate of 21%. There remains some uncertainty if a blended rate would apply to fiscal year entities in the transition year.
  • Generally, corporations with average gross income of $5 million or more during a prior three year period could not use the cash accounting method.  This rule has been replaced by a $25 million gross income test.

Qualified Business Income Deduction:

For small businesses, the new deduction for qualified business income is the most significant and complex part of the law. The deduction is an attempt to give a tax break equal to that provided to corporations for pass through entities.  I have read over 100 pages on the subject and the calculations and application of the limitations are too complex to cover here. There are several parts of the Section 199A law that are not addressed or still remain unclear to tax professionals as they work through various scenarios.  I will try to summarize the mechanics of the deduction below.
 

  • If you are a pass-through entity like a sole proprietor, a partner, a limited liability company (LLC) or an S corporation shareholder, you may qualify for a deduction of up to 20% of the qualified business income from the business, subject to certain limitations.  This does not apply to C corporations.  The deduction does apply to trusts and estates that own an interest in a pass-through entity.
  • Qualified business income (QBI) takes into account the net income from the business without regard for any amount paid by an S corporation that is considered reasonable compensation, guaranteed payment for services, or any amount paid to a partner for services outside his/her capacity as a partner.  Wages paid by the business may further play an important factor in calculating the deduction.  Depreciable assets are also used as a factor in the limitation formulas.
  • Taxable income includes all income reported on the return; so, for example, the income thresholds include income earned by a spouse, taxable pensions, and investment income.
  • A specified service trade or business is “any trade or business where the principal asset is the reputation or skill” of the owner and/or its employees; in contrast to a product that you sell.  Architects and engineers are exempt from the specified service business definition.
  • Some of the major areas that are still unclear include whether the deduction is taken before calculating self employment tax, the handling of self employed benefits such as health care and retirement funds, and rental income clarification.  It appears that this will not impact the calculation of self employment tax, however, the exact location of where this deduction will reside on the tax form has not been disclosed at the time of this article so this also remains uncertain.
  • Simplification of the limitations:
    • Regardless of the specified service business definition, all pass-through entities with taxable income less than $157,500 for single filers and $315,000 for joint filers will receive the full 20% of QBI deduction.
    • Specified service businesses with taxable income greater than $157,500/$315,000 but less than $207,500/$415,000 will get a partial deduction; and over $207,500/$415,000 will lose the deduction completely and would pay tax using their tax rate.
    • For all other businesses, if taxable income exceeds $157,500/$315,000 but is less than $207,500/$415,000 a partial deduction is calculated using wage and capital limitations; and the deduction is totally phased out when taxable income reaches $207,500/$415,000.
    • Although the thresholds appear to be the same for both specified service businesses and other businesses, formulas are applied differently.

 

Other Business Deductions:
 

Section 179 Deduction:
 

  • The maximum allowance is still limited to the amount of income from business activity.
  • Businesses can expense up to $1 million for the cost of qualified business property, up from $500,000.
  • The phase out provision has been increased to $2.5 million, up from $2 million and refers to the limitations applied to the deduction once the business has invested $2.5 million in new property.
  • The kinds of property that can be expensed under this section have been expanded to include furnishings for lodgings, new roofs, HVAC system and fire and security alarms for commercial buildings.
  • This deduction remains permanent.  No more guessing each year about how much to invest in capital equipment while the government tries to make up its mind.

 
 Bonus Depreciation:
 

  • Through 2022, businesses can deduct 100% of the cost of qualified property, up from 50%.
  • After 2022, the amount of bonus depreciation will decrease by 20% each year until it reaches 0% in 2027.  This is not a permanent provision; therefore, another act of Congress could revive it.
  • The new law also expands the definition of qualified property to include used equipment and film, television, and stage productions.
  • A new class of property, qualified improvement property, replaces the former class of qualified leasehold improvement property.  Qualified improvement property is defined as improvements to the interior of any nonresidential property placed in service after the date the building was first placed in service.  This class of property does not require that the building is at least 3 years old or that improvements are made subject to a lease agreement, as with the previous qualified leasehold improvement property definition.
  • The new provisions apply to assets with a recovery period of 20 years or less. This provision is complex and requires analysis on an asset by asset basis. To further complicate things, the new qualified improvement property class useful life was not specified in the new law.  The law was supposed to give this class of property a useful life of 15 years, which would qualify it for bonus depreciation.  This has yet to be addressed at the time of this article.
  • Business owners will get some relief for tax year 2017.  The new bonus depreciation provision applies to assets acquired and placed in service after September 27, 2017.
  • There are several other depreciation changes that affect vehicles and real estate assets.  Again, the topic is a little too complex for the average reader.

 
Meals & Entertainment:
 

  • The new law repeals the deduction for business related entertainment.  This includes tickets to sporting events, golf outings, theater tickets, and any other form of entertainment.
  • The deduction for business meals continues at the current limitation of 50% of the actual expense; however, the limitation has been expanded to include all business meals, including those provided to employees on the business premises for the benefit of the employer. Previously, such expenses had been fully deductible.

Net Operating Losses:

The deduction for net operating losses has been capped at 80% of taxable income. You are no longer allowed to carry back losses to prior years, but you now carry forward the loss indefinitely.

 
Limitation on Business Losses:

 
For 2018 through 2025, business losses for pass through entities are now capped at $250,000 for single filers and $500,000 for joint filers.  Any excess loss will carry forward to the following year.

Like Kind Exchanges:

Previously, businesses could trade vehicles and other equipment for like kind vehicles and equipment and defer any gain.  Under the new law, like kind exchange treatment has been restricted to real estate property only. Now trade-ins for like kind replacement property will be a taxable event and a buy and sell method must be used.  It is advised that you consult with your tax advisor before trading in business equipment or vehicles.

 
Conclusion:

There are several issues that still need to be addressed as tax professionals work their way through the new law.  I am sure many more questions will arise when applying the changes to real life tax client scenarios. 

I have found a wealth of information, in pretty easy to understand language, published on the Forbes and the CPA Practice Advisor websites.  For those of you that are math oriented, Forbes has a writer by the name of Tony Nitti who publishes very detailed articles with examples in his series “Tax Geek Tuesday”.

 Disclaimer: This post is intended to provide general information about the subjects posted.  It should no way be construed as tax or financial advisement.  We do not endorse any website or product introduced here.  Please contact Seacoast Accountability, a CPA, or a tax professional to discuss your particular tax or financial situation.  This information is subject to change.

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