The President signed the Tax Cuts and Jobs Act on December 22, 2017. For business owners, it has been the center of attention in Washington ever since. The problem is, most people never actually took the time to read it in its entirety as most of us do not have the time to thumb through the over 500-page bill plus the 600-page conference report that explained it. Sure, there is always Google which hosts a plethora of articles giving various broad explanations of all the new changes. However, you soon find that most of these internet finds lack the details that actually matter.
We want to be able to fully understand all these new details so that we can effectively share them with you and make sure you are “in the know” and taking full advantage where you can. So, we took the time to sort through and learn. Here are the changes that affect businesses and some tax planning opportunities that they have created.
For S Corporations And Other K-1 Entities
New 20% Deduction (1)
The big change for S corporations and other pass-through entities, which has received a lot of attention, is the new Code 199A deduction for qualified business income (QBI). Many business owners who do not pay corporate income taxes are now allowed to deduct 20% of their business income. Not every business is eligible for the 20% deduction, though. To determine your company’s eligibility, you must first know if it is a “specified service business.” That is defined as anything that relies primarily on its reputation for its business.
The deduction is allowed in full for singles with taxable income under $157,000 or married filers earning under $315,000. If your taxable income exceeds those amounts but is below $207,500 and $415,000, respectively, you will receive a prorated deduction. If your taxable income exceeds those phase-out limits and is a specified service business, you are not eligible for the 20% deduction.
If you don’t own a specified service business and your taxable income exceeds the phaseout limits above, then “wage limitations” will cap the initial 20% deduction amount. The “wage limitation” is the greater of either 50% of wages paid or 25% of wages paid plus 2.5% of capital. Qualified property for the 2.5% of capital includes “tangible property of a character subject to depreciation” and for which the depreciable period has not ended before the close of the taxable year. Sold property does not count, but all 3-, 5-, and 7-year assets will be taken into account for 10 years.
The 20% deduction is taken on QBI, which applies to K-1 Box 1, trade or business income. QBI does not include wages paid or other guaranteed payments. The deduction provides a reduction in taxable income but does not reduce gross income. Because of this, it will not affect deductions based on adjusted gross income (AGI) limitations.
For C Corporations (2)
Alternative Minimum Tax
The alternative minimum tax for C corporations was completely eliminated after the 2017 tax year. Beginning in 2018, the normal rates have changed as well. The various brackets that went up to 39% have been replaced with a 21% flat corporate tax rate.
This may tempt K-1 entities mentioned above to become C corporations, especially those ineligible for the Code 199A 20% deduction. The downside is that when a C corporation pays out its profits in wages it could face a marginal rate of up to 37% (let alone 2.9% in employment taxes for closely held companies). So, unfortunately, this negates any apparent benefits of changing entities.
Section 1202 Qualified Small Business Stock (3)
While the new 20% deduction adopts some of its language in restricting specified service businesses from Section 1202, they are not related. The Tax Cuts and Jobs Act does not make any changes to Section 1202. Taxpayers can still exclude 100% of the gain on up to $10 million of qualified small business stock issued after September 27, 2010, if they have held it for more than five years. If they have held it less than five years, they must roll the gain into a new qualified small business within 60 days.
Business assets such as commercial property and vehicles have traditionally been depreciated over time on schedules set by the tax code. However, Section 179 allows a business to take full depreciation in the first year. But, that only applies to select assets. Under the new law, a corporation can elect to either take 100% depreciation on an asset or spread out depreciation as done before, which provides a great tax planning opportunity for businesses.
The catch is that this can only be taken on qualified property acquired and placed in service on or after September 27, 2017. Such qualified property includes productions and plants bearing fruit or nuts since the “original use” rule has been eliminated as well. Also included as Section 179 property are HVAC units placed in service after November 2, 2017.
And this also greatly benefits businesses who are looking to switch to newer electric vehicles. The IRS has increased the luxury car cap from $3,160 to $10,000. Coupled with the additional bonus depreciation, up to an $18,000 depreciation deduction can be taken in 2018.
In addition, $1 million of Section 179 property may be immediately expensed beginning in 2018, with a phase-out threshold up to $2.5 million. These limits were increased from $520,000 and $2.07 million respectively. When making use of this bonus depreciation, one big thing you must remember that 1250 recapture will apply to an asset that is sold at a gain.
The Modified Accelerated Cost Recovery System (MACRS) tax depreciation system has been changed for mixed commercial and residential space. If over 20% of the proceeds come from business, it is depreciated over 39 years. If less than 20% of the proceeds come from business, it uses a 27.5-year schedule. Computers and peripheral equipment have also been removed from the LISTED PROPERTY list.
Net Operating Loss
The two-year carryback for net operating losses (NOLs) has been repealed for tax years ending after December 21, 2017, with the exception of farming NOLs. Instead, NOLs can be carried forward indefinitely. The NOL deduction is limited to 80% of taxable income.
The new tax law also repealed the employer-provided child care credit. Corporations that provide childcare or daycare will no longer be able to receive a credit for doing so. However, there is a new credit available to employers who pay for family and medical leave.
For wages paid after January 1, 2018, you get a credit of 12.5% of the amount of wages paid to “qualifying employees” during any period in which such employees are on Family and Medical Leave Act (FMLA) leave if the rate of payment is 50% of the employee’s normal wages. Credit is increased by 0.25% (not to exceed 25% total) for each percentage point by which the rate of payment exceeds 50%. This credit was designed to assist employers in retaining employees even while out on leave.
A number of employee benefit deductions were also eliminated. Transportation fringe benefits, such as paying for employee parking passes, as well as meals and entertainment, such as free meals in your employee cafeteria, have been eliminated. In 2018, only a 50% deduction will be allowed for expenses for food or beverages and to qualifying business meals.
Like-kind exchanges are now only allowed for real property and not tangible personal property, effective December 31, 2017. There are also changes in carried interest. It now requires a 3-year holding period to be considered a long-term capital gain. Also new this year, the cash method of accounting can be used by any taxpayer whose gross receipts do not exceed $25 million. To determine eligibility, receipts cannot exceed $25 million per year for the three prior tax years.
All businesses making more than $25 million in gross receipts are also subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income. This disallowed amount can be carried forward indefinitely.
The dividends received deduction has been increased to allow corporations to save more. The deduction goes from 70% to 50% for subsidiaries where less than 20% is owned, and from 80% to 65% for subsidiaries where less than 80% is owned.
Make Sure You Are Coming Out On Top
With so many changes made to the Internal Revenue Code, it is more important than ever to work with a professional who can help ensure you maximize these opportunities. At Newbridge Wealth Management, we can help identify potential opportunities for your business and lay out the tax planning opportunities you should consider. Email us at firstname.lastname@example.org, call us at 610.727.3960, or schedule a free 15-minute introductory phone call today!
Vincent R. Barbera, CFP® , MSFS is a managing partner and co-founder of Newbridge Wealth Management, a private financial counseling firm located in Berwyn, Pennsylvania. Believing in a patient, disciplined approach to investment management that delivers value and peace of mind, he utilizes a process-driven approach to financial planning that provides comfort and clarity to his client’s long-term goals. Along with a bachelor’s in psychology and business, he has a master’s in business and financial planning and Certified Financial Planner™ designation. Learn more by connecting with Vincent on LinkedIn or send him questions at email@example.com.