The Tax Cuts and Jobs Act Impact on Business Taxes

Mike Burt, CPA, MBA (Jan, 2018)

The Tax Cuts and Jobs Act signed by President Trump on December 22, 2017 is the largest tax overhaul our nation has seen since 1986.  Due to the speed with which this was pushed through Congress most changes, but not all, will go into effect in 2018.  Many of the business tax provisions, but not all, were made permanent.  Listed below are summaries of some of the major business tax provisions that were changed by The Tax Cuts and Jobs Act. 

Corporate Tax Rates

Effective January 1, 2018 all corporations are taxed at a flat rate of 21%, eliminating the graduated rates, and eliminating the flat 35% tax on personal service corporations.

Dividends Received Deduction

Corporations that receive dividends from corporate investments are eligible to take the Dividends Received Deduction (DRD). Under the Tax Cuts and Jobs Act the previous 70% DRD allowed is reduced to 50%, and the 80% DRD allowed is reduced to 65%. This change keeps the maximum rate that dividends are taxed at 10.5% (21% corporate rate x 50% dividend income taxed after the DRD).

Corporate Alternative Minimum Tax

Corporations will no longer be subject to Alternative Minimum Tax (AMT). However, if your company has an AMT credit carryforward, you will be eligible to receive a refund of the carryover. The credit will first be used to reduce tax, and any excess credit remaining is 50% refundable through 2020. In 2021, the credit is 100% refundable.

Business Interest Deductions

There is now a new limitation on the deduction of business interest. A company's business interest deduction for the year cannot exceed the sum of business interest income, 30% of adjusted taxable income, and any floor plan financing interest expense for the year. Any deduction of business interest that is limited in the current year may be carried forward indefinitely. However, taxpayers that meet the definition of a small business (average annual gross receipts that do not exceed $25 million for the three-tax year period ending with the prior taxable year), an electing real property trade or business, an electing farm business, or a public utility company will not be subject to the business interest deduction limitation.

Changes to Section 179 Deduction

The limits for Internal Revenue Code §179 have increased in 2018. The maximum §179 expense a taxpayer may claim is $1,000,000 and this will begin to be phased out at $2,500,000 of §179 purchases. The definition of qualifying §179 property has also been expanded to include qualified improvement property and property used to furnish lodging facilities such as dorms or apartments. In addition, the $25,000 limit for SUVs claiming §179 is now indexed for inflation.

Changes to Bonus Depreciation

For qualifying property purchased after September 27, 2017, the bonus depreciation rate has increased to 100%, with a phase-down beginning in 2023 for most assets. Property that qualifies for bonus depreciation now includes used property, as well as certain qualified film and theatrical productions. Vehicle dealer property and regulated public utility property are not eligible for bonus depreciation. Property that meets the definition of qualified improvement property has been expanded. The additional first year depreciation for passenger autos has been extended and will be increased for inflation.

Depreciation Changes for Farms

New machinery and equipment purchased for use in a farming business is eligible for a 5 year recovery period, rather than 7 years. This excludes cotton ginning assets, grain bins, fences, and other land improvements. In addition, farm businesses may now utilize the 200% declining balance method of depreciation rather than the 150% declining balance for depreciation, excluding 15 or 20 year property.

Other Depreciation Considerations

If you are an electing farm business or real property business discussed above in the business interest deduction limitation section, you must use ADS depreciation on certain assets. The ADS recovery period for residential rental property has been shortened to 30 years instead of 40 years. Computer equipment is no longer considered listed property.

Net Operating Losses

The Tax Cuts and Job Act of 2017 has repealed the two year carryback of Net Operating Losses, which was permitted under Pre-Act Law. In the case of a farming business or trade, a two year carryback may still be allowed in the event of losses suffered as the result of a disaster. The new law still permits Net Operating Losses to be carried forward twenty years, but the deduction will be limited to eighty percent (80%) of the taxable income. Any remaining losses may be carried forward indefinitely.

Like-Kind Exchanges

Under the Tax Cuts and Jobs Act, effective after December 31, 2017, the rule allowing the deferral of gain on like-kind exchanges is modified to allow for like-kind exchanges only with respect to real property that is not held primarily for sale. A transitional rule applies to pre-Act exchanges on property that has either been disposed of or on replacement property acquired on or before December 31, 2017. Exchanges of personal property and intangible property no longer qualify as tax-free exchanges (equipment, machinery, vehicles, patents, other intellectual property, artwork, collectibles, and other intangible business assets.

Business Deductions

  • The Domestic Productions Activities Deduction (DPAD) has been repealed effective December 31, 2017.
  • Starting January 1, 2022, Research and Experimentation expenses may no longer be deducted as incurred. After this date, Research and Experimentation expenses must be amortized over a five year period.
  • Amounts paid for sexual harassment settlements or payouts will be non-deductible expenses effective December 22, 2017.
  • Effective December 22, 2017 lobbying expenses with respect to local government bodies are no longer deductible.
  • Effective December 31, 2017 Performance-based remuneration and commissions now count towards employee compensation. Employers may deduct no more than $1 million with respect to a covered employee's compensation. 

Contributions to Capital

Under Pre-Act law, contributions to capital did not include contributions from a customer or potential customer. After December 22, 2017 contributions to capital will also exclude any contributions made by a governmental entity or civic group. A transition rule will permit the contribution of capital from governmental entities if they are pursuant to a master development plan approved prior to December 22, 2017.

Employer's Deduction for Fringe Benefit Expenses Limited

Deductions for entertainment expenses are disallowed for amounts incurred or paid after December 31, 2017.  After December 31, 2025, employers will no longer be able to deduct expenses associated with meals provided for employees on the business premises.

Tax Credits:  Additions, Limitations, and Repeals

Effective after December 31, 2017:

  • The Orphan Drug Credit has been reduced from 50% of clinical testing expenses to 25% of expenses.
  • The 10% credit for qualified rehabilitation expenditures with respect to a pre-1936 building is repealed, and a 20% credit is provided for qualified rehabilitation expenditures with respect to a certified historic structure which can be claimed ratably over a 5-year period.

Effective after December 31, 2017 thru December 31, 2019:

  • A new credit has been enacted which allows employers to deduct 12.5% of the wages paid during an employee’s family or medical leave. Employers may be able to increase this percentage, but not above 25%, if the wages paid during the leave exceed 50% of the employee's normal wages.

Partnership Terminations and Sales

For partnership tax years beginning after December 31, 2017 the rule providing for technical terminations of partnerships has been repealed. The repeal does not change the pre-Act law rule that partnerships are considered terminated if no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners. There is to be a mandatory basis adjustment (of transferee) if a partnership has built-in losses immediately after a transfer of partnership interest.  A substantial built-in loss also exists if the transferee would be allocated a net loss in excess of $250,000 upon a hypothetical disposition by the partnership of all partnership's assets in a fully taxable transaction for cash equal to the assets' fair market value, immediately after the transfer of the partnership interest.

Excess Business Losses

The excess farm loss limitation does not apply for tax years beginning after December 31, 2017 and before Jan. 1, 2026.  Instead, a non-corporate taxpayer's excess business loss is disallowed.  They are carried forward and treated as part of the taxpayer's net operating loss (NOL) carryforward in future tax years. This limitation applies after the application of the passive loss rules.

Accounting Method Change - Taxable Year of Inclusion

A taxpayer for tax years beginning after December 31, 2017 is required to recognize income no later than the tax year in which such income is taken into account as income on an applicable financial statement (AFS) or another financial statement under rules specified by IRS (subject to an exception for long-term contract income under (Code Sec. 460)).

The Act codifies the current deferral method of accounting for advance payments for services and goods under Rev Proc 2004-34 to allow taxpayers to defer the inclusion of income associated with certain advance payments to the end of the tax year following the tax year of receipt.  This applies only if such income is deferred for financial statement purposes. It also directs taxpayers to apply the revenue recognition rules under (Code Sec. 452) before applying the original issue discount (OID) rules under (Code Sec. 1272).

If any taxpayer is required by this provision to change its accounting method for its first tax year beginning after December 31, 2017, the change will be treated as initiated by the taxpayer and made with IRS's consent. For tax years beginning after December 31, 2018 the AFS conformity rule applies for OID with an adjustment period of six years.

Accounting Method Change - Cash Method

The cash method may be used by taxpayers (other than tax shelters) for tax years beginning after December 31, 2017 that satisfy a $25 million gross receipts test, regardless of whether the purchase, production, or sale of merchandise is an income-producing factor.  The use of the cash provisions will result in an accounting method change for purposes of Code Sec. 481.

Accounting Method Change - Inventories

Taxpayers that meet the $25 million gross receipts test for tax years beginning after December 31, 2017 are not required to account for inventories under (Code Sec. 471), but rather may use an accounting method for inventories that either: (1) treats inventories as non-incidental materials and supplies, or (2) conforms to the taxpayer's financial accounting treatment of inventories. The use of the inventory provisions will result in an accounting method change for purposes of Code Sec. 481.

Accounting Method Change - Long-Term Contracts

The exemption for small construction contracts from using percentage-of-completion method has been expanded to taxpayers that meet the $25 million gross receipts test. Also for contracts expected to be completed within 2 years.  

Excise Tax on Executive Compensation

Effective for tax years beginning after December 31, 2017 the new law creates an excise tax for applicable tax exempt organizations on all remuneration (not including excess parachute payments and income to licensed medical professionals for services provided) over $1 million paid to a “covered employee,” and excess parachute payments paid to the “covered employee.”  A “covered employee” is an employee (current or former) who was one of the five highest compensated employees of the organization for the current tax year or for any proceeding tax year beginning after December 31, 2016.  The excise tax rate equals the corporate tax rate of 21%.

Excise Tax on Income of Colleges & Universities

Effective for tax years beginning after December 31, 2017 certain private colleges and universities are now subject to an excise tax of 1.4% on net investment income.  The assets and net investment income of any “Related Organization” must also be included.  The affected institutions are those with at least 500 students, with at least 50% of the students located in the U.S., and with assets (excluding those used in directly carrying out the exempt purpose) of at least $500,000 per student.

Unrelated Business Taxable Income

Effective for tax years beginning after December 31, 2017 tax-exempt organizations with multiple unrelated trades or businesses cannot apply the losses from one unrelated trade or business to the profit derived from another unrelated trade or business.  Gains and losses have to be calculated and applied separately to each activity.

Tax Credit Bonds

Effective for tax years beginning after December 31, 2017 the Tax Cuts and Jobs Act changed provisions for advance refunding bonds and tax credit bonds.  Historically, states and local governments could issue advance refunding bonds creating two outstanding federally subsidized debt associated with the same activity.  An advance refunding bond is a refunding bond (used to pay the principal, interest, or redemption price on a prior bond issue) issued more than 90 days before the redemption of a refunded bond. Under the new law, interest on any bonds issued to advance refund another bond (regardless of whether it is a state or local government bond) cannot be excluded from gross income if issued after December 31, 2017.

Tax credit bonds provide investors tax credits in lieu of bond interest income.  The borrowing subsidy generally is measured by reference to a credit rate set by the Treasury Department. Tax credit bonds were issued for a variety of projects including clean renewable energy bonds, qualified energy conservation bonds, qualified zone academy bonds, and qualified school construction bonds.  The authority to issue tax-credit bonds is repealed for bonds issued after December 31, 2017.

This broad summary of the new Tax Cuts and Jobs Act should provide you with an awareness of some of the important tax changes facing us.  As expected, these summaries should lead to questions surrounding your business tax returns. Please feel free to contact your Dermody, Burke & Brown tax advisor to further discuss any questions you may have.

 

The information reflected in this article was current at the time of publication.  This information will not be modified or updated for any subsequent tax law changes, if any.

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