Business Year-End Tax Planning in Light of the 2018 Tax Reform Act

Thomas R. Tartaglia, CPA (Oct, 2018)

The Tax Cuts and Jobs Act (TCJA) has made some major changes to the tax provisions effective in 2018. Some of the major provisions include:

  • Lowering the corporate tax rate to 21%
  • Eliminating Alternative Minimum Tax (AMT)
  • Limitation on the deductibility of business interest
  • Increasing section 179 deduction to $1,000,000
  • Increasing bonus depreciation to 100%
  • Elimination of the 2 year net operating loss carryback period
  • Elimination of Like-Kind exchanges, except for real property
  • Elimination of the Domestic Activities Deduction
  • Created a 20% Qualified Business Deduction
  • Eliminated deductibility of entertainment expenses
  • Establishes employer credit for family or medical leave wages paid

Lowering the corporate tax rate to 21% and Eliminating Alternative Minimum Tax (AMT):

With the business tax rates lowered to a flat 21% it might be a good time to review your choice of entity. If you are currently an S-corporation should you revoke your "S-Election" and convert to a C-corporation and visa-versa, is now the time to convert your C-corporation to an "S"? Although the corporate tax rates have been significantly lowered and AMT eliminated, C-corporations still carry a double tax. This double tax can be mitigated by paying wages and not distributing accumulated earnings, but you will need to show a business purpose for accumulating earnings such as planned future expansion of facilities or product development. You must also consider how the new 20% qualified business deduction and elimination of the domestic activities deduction (both discussed later) impacts your personal and corporate tax rate. The 20% qualified business deduction is only available to pass thru entities (S-corporations, partnerships and sole proprietorships). This deduction will offset some of the tax savings from the lowered C-corporate tax rate. Changing your type of entity is a long term decision that requires careful consideration factoring in the fact that the qualified business deduction is a temporary provision expiring at the end of 2025 and the corporate tax rate is a permanent provision. Although the corporate tax rate is a permanent provision, and the qualified business deduction is temporary, there is no guarantee that these will not be changed down the road. There is no simple answer to this decision and each business entity must be analyzed on a case-by-case basis.

Limitation on the deductibility of business interest:

Business interest expense is limited to 30% of adjusted taxable income. Businesses with gross receipts of $25 million or less are not subject to this limitation, but if your business receipts exceed this threshold, you should consider analyzing how this provision will affect your deduction. If your interest deduction is severely limited, you may want to consider looking into re-structuring your debt to reduce interest expense. Any interest deduction that is not allowed in the current year can be carried forward indefinitely.    

Increased section 179 deduction and Increased bonus depreciation:

Utilizing the increased section 179 deduction ($1,000,000) in combination with the new (100%) bonus depreciation will give you virtually unlimited expensing capability. Note some states, including New York, do not follow the federal bonus depreciation guidelines, therefore requiring an add-back for state tax calculations.      

Elimination of Like-Kind exchanges, except for real property:

In the past, many businesses have utilized the like-kind exchange provisions to defer gain/loss recognition on the sale/trade-in of vehicles and equipment. Effective 1/1/18 this provision is now limited to qualifying real estate transactions so if you are planning on trading in a business vehicle or piece of equipment before year end you will need to consider the tax impact of the transaction.

Elimination of the Domestic Activities Deduction and Creation of a 20% Qualified Business Deduction:

The Domestic Activities Deduction has been eliminated, in its place a 20% Qualified Business Deduction has been created. The Domestic Activities Deduction was a deduction that was available to all types of manufacturing business entities. As mentioned earlier the 20% Qualified Business Deduction is available only to specified pass-thru entities and single member entities. If qualified it is a deduction calculated on the individuals' personal income. The deduction is based on up to 20% of qualified business income (QBI), but there are limitations and phase-out thresholds that can reduce or eliminate the deduction. The allowance of the 20% deduction is treated independently by each state, specifically New York has not formally adopted the deduction and as of this writing it appears they will not allow a deduction.

Things to consider before year end might include limiting guaranteed payments to partners in a partnership as these payments are not considered a part of QBI but are includable in taxable income and therefore may cause the deduction to be limited or phased out completely. Also manage your (personal) taxable income to stay below the phase out thresholds and preserve the full deduction.     

Entertainment Expenses & Deduction for Meals: 

The new law eliminated the deduction for any expenses related to entertainment, amusement or recreation activities.

However, taxpayers can continue to deduct 50% of the cost of business meals if the taxpayer or an employee of the taxpayer is present, and the food or beverages are not considered lavish or extravagant. The meals may be provided to a current or potential business customer, client, consultant or similar business contact. Food and beverages that are purchased or consumed during entertainment events will not be considered entertainment if they are purchased separately from the entertainment or the cost is stated separately from the entertainment on one or more bills, invoices or receipts. Extra care must be taken when recording these types of activities in your books and records in order to insure the proper deductions, you may want to consider modifying your chart of accounts to accommodate segregating these expenses.

Employer credit for family or medical leave wages paid:

Wages paid to employees during the time periods beginning 1/1/18 thru 12/31/19 may qualify for the employer credit. To qualify for the credit, (1) Wages must be paid to an employee while they are on family or medical leave (2) Only employees paid wages of $72,000 or less (in 2017) qualify (3) The wage base paid must be equal to at least 50% of the wages you would have normally paid the employee and (4) the amount of leave used to calculate the credit cannot exceed 12 weeks for an employee for any taxable year. You (the employer) must have a written leave policy covering all qualifying employees stating (1) wages will be paid at a rate of at least 50% of the employees normal wages (2) all qualifying full-time employees will receive at least two weeks of annual paid leave and (3) all less than full-time employees must be given leave on a pro rata basis. 

The new tax law provides opportunities for businesses to save tax dollars and improve business operations. As you can see there are many components of the new tax law and therefore no single right answer, planning decisions will have to be made on a case by case basis. Please be sure to discuss your personal situation with the tax professionals at Dermody, Burke & Brown, CPAs.

 

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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