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THE TAX CUTS AND JOBS ACT: Changes to Business Taxation

CHANGES TO BUSINESS TAXATION

CORPORATE TAXES

The Act establishes a permanent flat 21% corporate tax rate beginning in the 2018 tax year, a sweeping departure from the old rate of 35%. It also repeals the corporate Alternative Minimum Tax and reduces the dividends received deduction from 80% and 70% to 65% and 50%, respectively.

BUSINESS INTEREST DEDUCTIONS

A cap has been set on net interest expense deduction at 30% of adjusted taxable income, among other criteria, but provides an exception to small businesses averaging gross receipts of $25,000,000 or less.

Additionally, a taxpayer may elect to exclude from the limitation a real property trade or business. A real property trade or businesses is defined as any real estate development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing or brokerage trade or business. Thus, interest paid or accrued in the real property trade or business is not subject to the net interest expense limitation (mentioned above) by electing to use the alternative depreciation system (ADS).

BONUS DEPRECIATION

To incentivize businesses to grow and invest, the new law increases the 50% bonus depreciation to 100% for property placed in service after September 27, 2017 and before January 1, 2023. Longer production period property and certain aircrafts have slightly longer time to receive the 100% bonus depreciation. After that, a 20% phase-down schedule will take effect each following year. Additionally, the new law removes the previous requirement for the property to be new when placed into service by the taxpayer, allowing bonus depreciation on the purchase of used property.

Bonus depreciation rates are as follows:

  • 100% for property placed in service after September 27, 2017, and before January 1, 2023
  • 80% for property placed in service after December 31, 2022, and before January 1, 2024
  • 60% for property placed in service after December 31, 2023, and before January 1, 2025
  • 40% for property placed in service after December 31, 2024, and before January 1, 2026
  • 20% for property placed in service after December 31, 2025, and before January 1, 2027
  • 0% (bonus expires) for property placed in service after December 31, 2026

SECTION 179 EXPENSING

The maximum amount a taxpayer is allowed to expense has increased to $1,000,000 and the phase-out threshold for the maximum investment amount has increased to $2,500,000. These limits are to be indexed for inflation beginning after 2018. The new law also expands the definition of §179 to include certain depreciable tangible personal property used predominantly to furnish lodging, such as appliances and furniture, while computers and peripheral equipment have been removed from the definition of listed property. The definition of qualified real property eligible for §179 has also been expanded to include improvements to non-residential property such as roofs, HVAC systems, fire protection, and alarm/security systems.

DEPRECIATION OF REAL PROPERTY

Prior to the new legislation, qualified improvement property was only eligible for the 15-year recovery period and bonus depreciation as long as it also met the definition of a qualified leasehold improvement, a qualified retail improvement, or a qualified restaurant improvement. If the 15-year recovery period did not apply, then the qualified improvement property was depreciated over 39 years, the recovery period for a non-residential building.

For property placed in service after December 31, 2017, these different property classes have been eliminated and, according to the committee report, Congress intended to assign a 15-year recovery period for all assets considered to be qualified improvement property (defined as any improvement to an interior portion of a building which is non-residential real property, if the improvement is placed in service after the date the building was first placed into service by the taxpayer). It does not include expenditures incurred from the enlargement of a building, elevators or escalators, or any internal structural framework.

*Note: The final version of the reform bill inadvertently omits the provision which would have given a 15-year recovery period for qualified improvement property, and a technical correction will be needed to create this recovery period. Without a technical correction, all property in this category will be treated as 39-year non-residential real property, effective for property placed in service after December 31, 2017, and will not be eligible for bonus depreciation.

The ADS recovery period for residential rental property has also been reduced from 40 years to 30. The ADS recovery period for non-residential property remains at 40 years.

VEHICLE DEPRECIATION

The limit placed on depreciation write offs for business vehicles has been increased as follows:

Year 1 — $10,000 (up from $3,160) ($18,000 if bonus depreciation is claimed)

Year 2 — $16,000 (up from $5,100)

Year 3 — $9,600 (up from $3,050)

Each subsequent year — $5,760 (up from $1,875) until the cost is fully recovered

These new limits become effective for property placed in service after December 31, 2017 and will be indexed for inflation after 2018.

CARRIED INTEREST

The Act increases the holding period to three years for long term capital gains relating to certain partnership interests transferred in connection with the performance of services. The interest receives long-term capital gain treatment if held for at least three years and is treated as short-term gain and taxed at ordinary rates if held for fewer than three years.

DOMESTIC PRODUCTION ACTIVITIES DEDUCTION (DPAD)

This deduction has been entirely repealed as of January 1, 2018.

LIKE-KIND EXCHANGES

The like-kind exchange of property used in a trade, business, or for investment purposes has been limited to real property only.

MEALS & ENTERTAINMENT

The deduction for meals remains unchanged, limited to 50% of the expense, but has been temporarily expanded through 2025 to include meals provided to employees through an eating facility that meets the requirement for de minimis fringes and for the convenience of the employer. Most deductions for expenses from any form of entertainment, amusement, or recreation are now eliminated. Some entertainment expenses remain deductible including expenses for recreational, social, or similar activities primarily for the benefit of non highly compensated employees.

TRANSPORTATION & COMMUTING BENEFITS

Expenses paid or incurred after 2017 associated with providing qualified transportation fringes to employees (i.e. transit passes, parking fees, and shuttle services provided to employees for commuting between their residence and place of employment) can no longer be deducted. An exception is made when the costs are deemed necessary to ensure employee safety, for example, taxi rides for employees after a company party with an open bar.

PASS-THROUGH BUSINESSES

The Act allows taxpayers who have domestic qualified business income from partnerships, S corporations, or sole proprietorships to deduct 20% of business-related income, subject to certain limits and exceptions. This provision was put in place so that flow-through owners can retain their competitive advantage over C corporations.

 

Qualified business income (QBI) is defined as the net amount of items of income, gain, deduction, and loss with respect to the trade or business. Specified investment-related items, however, such as capital gains and losses, dividends, and interest income, are excluded unless the interest is properly allocable to the business. In addition, QBI does not include reasonable compensation received from an S corporation, or a guaranteed payment received from a partnership for services provided to a partnership's business.

Generally speaking, the deduction cannot exceed 20% of the excess of the individual taxpayer’s taxable income (reduced by net capital gain). If QBI is less than zero, it is treated as a loss from qualified business in the following year. Additionally, rules are in place to deter high-income taxpayers from attempting to convert wages or other compensation for personal services into income eligible for the deduction. For taxpayers with taxable income less than $157,500 ($315,000 for joint filers), there are no limitations to the 20% deduction. Once the taxable income exceeds those thresholds, limitations on the deduction are phased in based either on wages paid or on wages paid plus a capital element. There is a short range of income in excess of these thresholds where the W-2 limitation is phased in, but by the time taxable income reaches $415,000 (if married, $207,500 if single), the 50% W-2 wage limitation applies in full.

Additional limitations apply for businesses offering certain personal services, (i.e. accounting services, medical services, legal services, etc.) to prevent them from converting their salaries and wage income, which are taxed at ordinary rates, into profits taxed at lower rates. If the individual taxpayer’s specified service business taxable income is below the phase out thresholds listed above ($415,000 for joint filers and $207,500 for single filers), they are allowed to claim a modified deduction.

The deduction is taken “below the line,” meaning that it reduces the taxable income but not the adjusted gross income. It is available regardless of the taxpayer’s choice to itemize deductions or take the standard deduction, though it does not reduce income subject to self-employment tax. This new provision is eligible for tax years beginning January 1, 2018 through December 31, 2025.

NET OPERATING LOSSES

Net operating loss deductions are limited to 80% of taxable income for losses arising in tax years beginning on or after January 1, 2018. The new law entirely repeals the option to carry back the loss while allowing it to be carried forward indefinitely.

EXCESS BUSINESS LOSSES

The Act defines “excess business loss” as the excess of taxpayer’s aggregate deductions attributable to the taxpayer’s trade or business for that year, over the sum of their aggregate gross income or gain for the year, plus a “threshold amount” of $500,000 for married individuals filing jointly, or $250,000 for all other individuals. Excess business losses of non-corporate taxpayers are disallowed for tax years beginning between January 1, 2018 and December 31, 2025. Instead, any excess business loss that is disallowed is carried over and treated as part of the taxpayer’s net operating loss carryforward in subsequent years. The provision applies after passive activity loss rules have been taken into account.

RESEARCH AND DEVELOPMENT

The new legislation leaves the Research & Experimentation Tax Credits (R&D Tax Credits) unchanged. The deduction for research and development costs, however, is now required to be amortized over a five-year period beginning with the midpoint of the taxable year in which such expenditures are incurred.

TECHNICAL TERMINATIONS

Effective for tax years beginning after December 31, 2017, The Act repeals rules which consider a partnership to be terminated if a sale or exchange of 50% or more of the total interest in a partnership occurs within a 12-month period.

 

For more details related to the changes described above or if you have any questions, please feel free to contact us.