The new tax law, The Tax Cuts and Jobs Act (“TCJA”), will affect both big and small businesses. Signed on December 22, 2017 by President Trump, most changes are permanent changes (unlike the individual tax provision changes) and beginning in 2018, will provide significant tax saving opportunities.
Key changes affecting businesses are highlighted here as follows:
1. Lower Tax Rates:
Taxpayers who are C corporations, a flat tax rate of 21% replaces the old graduated tax rate structure which topped out at a rate of 35%(1). In addition, the corporate alternative minimum tax (“AMT”) has been repealed(2).
For S corporations, partnerships, limited liability companies (LLC’s) and sole proprietorships; these entities (“pass-through” entities) can now deduct 20% of their net business income on their personal income tax returns. Therefore, owners will now pay tax on 80% of their net income from their business. The 20% deduction is to be against taxable income, rather than adjusted gross income(3). This deduction however, is phased out for individuals who are owners of certain service businesses, other than engineers and architects. The phase out kicks in at a taxable income of $157,500 for single tax filers and at $315,000 for married filing joint tax filers. In addition, for all businesses, other than sole proprietorships, the 20% deduction cannot exceed the greater of:
(A) 50% of wages paid by the business or
(B) the sum of 25% of wages paid by the business, PLUS 2.5% of the cost of “qualified property,”( i.e. tangible, depreciable property held and used in the business at the end of the business tax year which have not been fully depreciated)
2. Section 179 Expense Increase:
Beginning in 2018, taxpayers can deduct immediately up to $1 million of tangible personal property (up from $510,000), new or used, placed in service by the business. The deduction phases out at $2.5 million of purchased property (up from $2 million). The restriction that the section 179 expense deduction CANNOT decrease the business taxable income below zero, remains unchanged(4).
3. Bonus Depreciation Increase:
For purchases of tangible personal property, new or used, placed in service after September 26, 2017, 100% (up from 50%) is deductible against business income(5). Unlike section 179, there is no phase out for bonus depreciation and this deduction CAN reduce business taxable income BELOW zero. This provision remains in effect through tax years ending before January 1, 2023. The percentage deduction phases out as follows after December 31, 2022: 2023-80%; 2024-60%; 2025-40%; 2026-20%; and 2027- the deduction is completely phased out.
4. Luxury Auto Depreciation:
Under the old law, very modest amounts were allowed for “luxury autos” used in a business. These modest amounts have been increased beginning in 2018 to a maximum first year deduction of $10,000 (for 100% business use auto), up from a mere $3,160 in 2017(6).
5. Entertainment Expenses:
Beginning in 2018, amounts paid for entertainment are fully disallowed. Accordingly, amounts paid for entertainment, amusement or recreational activities, or membership dues relating to such activities, or other social purposes will no longer be deductible. So, for example, golf outings with clients or tickets to a sporting event or play are no longer deductible.
The old law, which permitted a deduction of 50% for entertainment still applies for MEALS AND BEVERAGES and is expanded to include meals provided on the employer’s premises. The elimination of deductions for entertainment expenses does away with the subjective determination of whether such expenses are “sufficiently business related”(7).
6. Interest Expense Deduction Limitations:
All businesses will now be subject to an interest expense deduction disallowance (determined at the entity level) for interest expense in EXCESS of 30% of the business’s “adjusted taxable income.” The definition here of “adjusted taxable income” is the business’s taxable income, computed without regard to the amount of the interest expense, interest income, taxes, net operating losses, depreciation, and amortization. In simple terms, interest expense will be allowed to be deducted, but will be limited to 30% of the business’s EBITDA (earnings before interest, tax, depreciation and amortization). It should be noted that for years ending after December 31, 2021, the 30% allowance will be calculating using only EBIT (earnings before interest and taxes).
An exemption from this rules applies for business taxpayers with average annual gross receipts for the three-tax year period ending with the prior taxable year of under $25 million.
7. Cash Basis Method of Accounting:
Businesses will now be allowed to use the simpler and more flexible cash basis method of accounting for tax purposes. The new law raises the gross receipts test to $25 million. The gross receipts test is based on average annual gross receipts for the three-tax year period ending with the prior taxable year of under $25 million(8). This increase will make it possible for more businesses to use this preferred tax basis method.
8. Completed Contract Method of Accounting:
Using the same “under $25 million gross receipts test”, a contractor will be will be given the “SMALL CONTRACTOR EXEMPTION,” as long as they are under the $25 million average and so long as their contracts are estimated to be completed within two years of the start of construction(9). If so, the contractor can use the completed contract method. This method is the most tax-advantageous method for contractors in that it gives the maximum amount of tax-deferral to the contractor as tax is paid on income from the contract only when the contract is 100% complete.
For further information or for questions, please contact your tax professional at Castellano, Korenberg & Co.
***LOOK OUT FOR “THE TCJA - HOW IT WILL AFFECT YOUR PERSONAL TAXES,” TO BE PUBLISHED NEXT WEEK.***
1: IRC 11(b), as amended by Act Sec. 13001
2: IRC 5S, as amended by Act Sec. 12001
3: IRC 62(a), as amended by Act Sec 11011(b)
4: IRC 179, as amended by Act Sec. 13101
5: IRC 168, as amended by Act Sec. 12001
6: IRC 280F, as amended by Act Sec. 13202
7: IRC 274, as amended by Act Sec. 13304
8: IRC 448, as amended by Act Sec. 13102
9: IRC 460(e), as amended by Act Sec. 13102
ARTICLES INCLUDED HEREIN DO NOT CONSTITUTE AN OPINION AND ARE NOT INTENDED OR WRITTEN TO BE USED, AND THEY CAN NOT BE USED, BY ANY TAXPAYER FOR THE PURPOSE OF AVOIDING PENALTIES THAT MAY BE IMPOSED ON THE TAXPAYER. This publication is designed to present matters of general interest relating to accounting, taxation and business management.