On December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was signed into law. This will mark a fundamental change in the way businesses will calculate taxable income, and subsequently affect the amount of federal tax you will pay. Here are a few changes effective in 2018 that will affect your business returns this year:
“C” Corporate Tax Rate. One of the more significant new law provisions cuts the corporate tax rate to a flat 21%. Before the new law, rates were graduated, starting at 15% for taxable income up to $50,000, with rates at 25% for income between 50,001 and $75,000, 34% for income between $75,001 and $10 million, and 35% for income above $10 million.
“C” Corporate Alternative Minimum Tax. The corporate alternative minimum tax (AMT) has been repealed by the new law.
“Qualified Business Income” deduction (Section 199A deduction). Beginning in 2018, there will be up to a 20% deduction from net business income for a sole proprietorship, LLC (excluding those taxed as a C corporation), partnership, S corporation, and rental activity. The rules are incredibly complex but there is a lot of planning that we can do to maximize this deduction for you.
100% Bonus Depreciation. Previously, an additional first-year bonus depreciation was allowed equal to 50% of the unadjusted basis of new qualified property. Effective 9/27/17, a 100% first year bonus depreciation deduction for the adjusted basis is allowed for new or used qualified property acquired and placed into service after 9/27/17.
Section 179 expensing election. The new law increases the maximum amount that may be expensed under Code Sec. 179 to $1 million. If more than $2.5 million of property is placed in service during the year, the $1 million limitation is reduced by the excess over $2.5 million. Both the $1 million and the $2.5 million amounts are indexed for inflation after 2018. The expense election has also been expanded to cover (1) certain depreciable tangible personal property used mostly to furnish lodging or in connection with furnishing lodging, and (2) the following improvements to nonresidential real property made after it was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; security systems; and any other building improvements that aren’t elevators or escalators, don’t enlarge the building, and aren’t attributable to internal structural framework.
Depreciation of qualified improvement property. The new law provides that qualified improvement property is depreciable using a 15-year recovery period and the straight-line method. Qualified improvement property is any improvement to an interior portion of a building that is nonresidential real property placed in service after the building was placed in service. It does not include expenses related to the enlargement of the building, any elevator or escalator, or the internal structural framework. There are no longer separate requirements for leasehold improvement property or restaurant property.
Luxury auto depreciation limits. Under the new law, for a passenger automobile for which bonus depreciation (see above) is not claimed, the maximum depreciation allowance is increased to $10,000 for the year it’s placed in service, $16,000 for the second year, $9,000 for the third year, and $5,760 for the fourth and later years in the recovery period. These amounts are indexed for inflation after 2018. For passenger autos eligible for bonus first year depreciation, the maximum additional first year depreciation allowance remains at $8,000 as under pre-Act law.
Domestic Production Activity Deduction (DPAD). This deduction, also referred to as the domestic manufacturing deduction, was a tax break for businesses that perform domestic manufacturing and certain other production activities. Under the TCJA, the DPAD deduction is no longer available starting with the 2018 tax year.
Business Entertainment not deductible. The cost to “entertain” clients for business purposes such as season tickets to sports events or golfing with your clients was 50% deductible. Under the TCJA, entertainment will no longer be deductible. In your chart of accounts, we advise you to separate out your meals and entertainment expenses into two separate general ledger items effective immediately.
Like-kind exchange treatment limited. Under the new law, the rule allowing the deferral of gain on like-kind exchanges of property held for productive use in a taxpayer’s trade or business or for investment purposes is limited to cover only like-kind exchanges of real property not held primarily for sale. Under a transition rule, the pre-TCJA law applies to exchanges of personal property if the taxpayer has either disposed of the property given up or obtained the replacement property before 2018.
Business Interest Expense. Under the new law, every business, regardless of its form, is limited to a deduction for business interest equal to 30% of its adjusted taxable income. For pass-through entities such as partnerships and S corporations, the determination is made at the entity, i.e., partnership or S corporation, level. Adjusted taxable income is computed without regard to the repealed domestic production activities deduction and, for tax years beginning after 2017 and before 2022, without regard to deductions for depreciation, amortization, or depletion. Any business interest disallowed under this rule is carried into the following year, and, generally, may be carried forward indefinitely. The limitation does not apply to taxpayers (other than tax shelters) with average annual gross receipts of $25 million or less for the three-year period ending with the prior tax year. It also does not apply to Flooring Interest incurred by Auto Dealerships. Real property trades or businesses can elect to have the rule not apply if they elect to use the alternative depreciation system for real property used in their trade or business. Certain additional rules apply to partnerships.
New Fringe Benefit Rules. The new law eliminates the 50% deduction for business-related entertainment expenses. The pre-Act 50% limit on deductible business meals is expanded to cover meals provided via an in-house cafeteria or otherwise on the employer’s premises. Additionally, the deduction for transportation fringe benefits (e.g., parking and mass transit) is denied to employers, but the exclusion from income for such benefits for employees continues. However, bicycle commuting reimbursements are deductible by the employer but not excludable by the employee. Last, no deduction is allowed for transportation expenses that are the equivalent of commuting for employees except as provided for the employee’s safety.
Reimbursable plans vs allowance plans. Employees who had unreimbursed employee expenses would previously file Form 2106 and be able to write off their unreimbursed expenses on their individual return subject to a 2% floor of their adjusted gross income. Under the new law, these unreimbursed employee expenses will no longer be deductible. Therefore, we encourage you to consider a reimbursable plan for your employees’ out of pocket expenses.
These are the most common changes, and at your tax interview this year we will discuss any other changes that might affect you. As these changes are not simple, we suggest a separate appointment to go over the changes that apply to your situation and to talk about how to maximize your tax benefit. Contact us at 714.672.0022 to setup your appointment with your professional tax team members.
