On Dec. 22, 2017 President Trump signed into law H.R. 1, the new tax reform act. While some changes started in 2017, most will go into effect this year. Some are permanent, but other provisions change year to year or expire after Dec. 31, 2025.
While the act was meant to simplify the tax code, it actually added 573 sections to the Internal Revenue Code. Even the official title of the bill is not simple:
An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018 formerly known as The Tax Cut and Jobs Act (H.R. 1).
H.R. 1 will reduce taxes for most, but not everyone will benefit from the changes. Corporations that are taxed as a C-Corporation will benefit significantly from the new tax act, so much so that some businesses are considering electing to change their tax status to a C-Corporation. This is not something a business should rush into without properly looking at the long-term tax consequences of such a change, however, especially since corporate tax rates can be changed in the future.
C-Corporation Provisions
What makes this election so attractive is that in the new tax act, instead of several levels of tax rates with the top tax bracket at 35 percent, C-Corporations will have a flat tax rate of 21 percent effective Jan. 1. For corporations with fiscal year-ends, there will be blended rates for years beginning in 2017 and ending in 2018 to allow for the tax rate change.
The new act also eliminates the special personal service corporation tax rate of a flat 35 percent and eliminates the corporate alternative minimum tax. Some of the other changes to C-Corporation that could have a negative impact on taxes include the reduction of the dividends-received deduction and a limitation on net operating losses.
Pass-Through Business Income
To help businesses that are not taxed as a C-Corporation, the act allows for an individual to take a deduction of 20 percent of “qualified business income” from a pass-through entity. This deduction does not apply to income deemed to be wages or salaries. While this deduction can be significant for some taxpayers, it certainly complicates the individual tax return and businesses will be required to disclose more information to its owners than previously reported in order for owners to calculate the deduction.
The provision should benefit most individuals who own businesses taxed as a pass-through, but depending on taxable income levels and the type of business, some will not be able to take advantage of this deduction, or will see limitations.
For example, if your taxable income is less than $157,000 (single filers) or $315,000 (joint filers), there are no limitations on the deduction. If your taxable income is over $207,500 (single filers) or $415,000 (joint filers) and you are a business that falls into a “service business,” there will be no deduction allowed. A service business would include the fields of:
• Health;
• Law;
• Accounting;
• Actuarial science;
• Performing arts;
• Consulting;
• Athletics;
• Financial services;
• Brokerage services; and
• Any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its owners or employees.
If your taxable income is over $207,500 (single filers) or $415,000 (joint filers) and you are NOT a business that falls into a “service business,” there are other limitations in place to determine the allowable deduction. These limitations are based upon wages paid to employees and/or investment in tangible personal property (i.e. equipment).
Equipment Expensing
Businesses that invest in equipment will experience significant tax savings as a result of an increase in business expensing of asset purchases, new or used. This is the one item of the law passed that will allow taxpayers to take advantage of a deduction in 2017 and was expanded to include used property that is new to the taxpayer. Any equipment purchased from Sept. 27, 2017 to Dec. 31, 2022 can be 100 percent expensed through bonus depreciation. After 2022, the expensing decreases by 20 percent every year from tax years 2023 to 2027 as shown below.
| Equipment Purchased Year | Expensing |
|---|---|
| 9/27/17 to 12/31/2022 | 100% |
| 2023 | 80% |
| 2024 | 60% |
| 2025 | 40% |
| 2026 | 20% |
| 2027 | 0% |
Increased Depreciation Expensing
The new act also increases depreciation expensing under Section 179 from $500,000 in 2017 to $1 million in 2018. The allowable depreciation expense amounts on passenger automobiles placed in service after 2017 also increases, plus the act shortens the depreciation life for all qualified improvements to real property to 15 years.
Business Interest Expense
One of the deductions that businesses have always been allowed, but under the new tax act could be limited, are business interest expenses. This limitation does not apply to businesses that meet the $25 million or less gross-receipts test or floor-plan financing. The good news is that any interest not allowed can be carried forward indefinitely.
The interest expense deduction is limited to the sum of:
• Business interest income for the tax year.
• 30 percent of the adjusted taxable income of the taxpayer for the tax year.
• Floor-plan financing interest of the taxpayer for the tax year.
Repealed Deductions
Some not-so-good news that came out of this act was the repeal of the following deductions for all business entities:
• Domestic production activities deduction;
• FDIC premiums paid by large banks;
• Deduction for all business entertainment except for food and beverage;
• Limits meals provided for the employer’s convenience to 50 percent instead of 100 percent;
• Deduction for transportation fringe benefit such as paid parking and bicycle reimbursements; and
• Deduction for employee moving expenses as fringe benefit.
Other Provisions
Some other changes for businesses include limits to like-kind exchanges to real property only. Like-kind exchanges are the disposal of one asset and acquisition of another without creating a tax liability from the sale of the original asset. Under the new law, taxpayers can no longer apply these rules to tangible personal property, such as equipment.
H.R. 1 provided some changes in business credits, which include limits to credits for clinical testing expenses for certain drugs used to treat rare diseases, and a change in the rehabilitation credit to require the credit to be taken over five years.
The bill also created a new credit to businesses for payments to employees on family or medical leave. The new credit could be a 12.5 percent to 25 percent credit if the employee is paid at least two weeks and 50 percent or more of wages. This does not include amounts paid under sick, vacation or personal time-off.
The new tax act overall should provide a reduction of taxes for most businesses, whether taxed as a C-Corporation or as a pass-through entity, but businesses should look at their tax structure to obtain optimal results under the new law.
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