Key Business Provisions of The Tax Cuts and Jobs Act
The following summarizes the key provisions of the Tax Cuts and Jobs Act (the Act) as it relates to businesses.
Corporate Tax Rate Reduction. For taxable years beginning after December 2017, the corporate tax rate is a flat 21%. The 21% tax rate also applies to personal service corporations. It appears that the rate will be pro-rated for fiscal year filers if the taxable year includes January 1, 2018.
Dividend Received Deductions. The 80% dividends received deduction is reduced to 65% and the 70% dividends received deduction to 50%.
Corporate Alternative Minimum Tax. The corporate AMT is eliminated. Taxpayers that have AMT credit carryforwards will be able to use them against their regular tax liability and will also be able to claim a refundable credit equal to 50% of the remaining AMT credit carryforward in years beginning in 2018 through 2020 and 100% for years beginning in 2021.
Pass-Through Entities. The Act generally allows a non-corporate taxpayer (including a trust or estate) who have qualified business income (“QBI”) from a partnership, S corporation or sole proprietorship (pass-through entities) to deduct the lesser of:
QBI is defined as all domestic (U.S.- source, including Puerto Rico) business income other than investment income. QBI does not include any amount that is treated as reasonable compensation of the taxpayer for services rendered to the business (W-2 salary for S corporation) or any amount paid by a partnership that is a guaranteed payment for services performed. The 20% deduction is not allowed in computing adjusted gross income but rather is allowed as a deduction reducing taxable income.
For pass-through entities, the deduction cannot exceed the greater of:
Qualified property is generally defined as tangible, depreciable property that is held by, available for use, and used in the qualified trade or business at the close of the taxable year.
For a partnership or S corporation, each partner or shareholder is treated as having W-2 wages for the taxable year in an amount equal to his or her allocable share of the entity’s W-2 wages for the tax year.
The W-2 wage limit does not apply in the case of a taxpayer with taxable income not exceeding $315,000 for married individuals filing jointly ($157,500 for other individuals). This limitation is phased-in for individuals with taxable income exceeding these thresholds over the next $100,000 of taxable income for married taxpayers filing jointly ($50,000 for other individuals).
Thresholds and Exclusions
The deduction does not apply to “specified service businesses,” which means any trade or business that involves the performance of services for any trade or business where the principal asset of such trade or business is the reputation or skill of one or more employees or owners. These include the areas of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services.
The Act specifically excludes engineering and architecture services from the definition of specified service business. This exclusion does not apply for a taxpayer whose taxable income does not exceed $315,000 for married individuals filing jointly ($157,500 for other individuals). The deduction for service businesses is phased out over the next $100,000 of taxable income for joint filers ($50,000 for other individuals).
Excess Business Losses of Taxpayers Other than Corporations. The Act implements a new rule, which states that “excess business losses” of a taxpayer other than a corporation are not allowed for the taxable year but are instead carried forward and treated as part of the taxpayer’s net operating loss (“NOL”) carryforward in subsequent tax years. This limitation applies after the application of the passive activity loss rules. NOL carryovers generally are allowed for a taxable year up to the lesser of the carryover amount or 80% of taxable income.
An excess business loss for the taxable year is the excess of the taxpayer’s aggregate deductions attributable to his/her trade and businesses over the sum of aggregate gross income or gain of the taxpayer, plus a threshold amount. The threshold amount for a taxable year is $500,000 for married taxpayers filing jointly and $250,000 for other individuals, with both amounts indexed for inflation.
Increased Bonus Depreciation. Businesses are generally allowed to write off (expense) a percentage of the cost of depreciable assets that are acquired and placed in service from September 28, 2017, to December 31, 2026. The write-off percentages are as follows:
|9/28/17 to 12/31/22||100%|
Depreciation Limitation for Luxury Automobiles and Personal Use Property. For passenger automobiles placed in service after December 31, 2017 and for which bonus depreciation is not claimed, the luxury automobile depreciation limitation is increased to a maximum of $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year and $5,760 for the fourth and later years. The limitations are indexed for inflation for automobiles placed in service after 2018.
Section 179 Expensing. The “Section 179” small business expensing limitation is increased to $1,000,000, and the phase-out threshold is increased to $2,500,000, effective for property placed in service in taxable years beginning after December 31, 2017. These amounts are indexed for inflation. The definition of qualifying property is expanded to include certain improvements to real property.
Recovery Period for Real Property. The provision eliminates the separate definitions of qualified leasehold improvement, qualified restaurant and qualified retail improvement property and provides a straight-line, 15-year recovery period for qualified improvement property and a 20-year “alternative depreciation system” (“ADS”) recovery period for such property. The ADS recovery period for the residential rental property is reduced from 40 to 30 years. Both of these rules are effective for property placed in service after December 31, 2017. The recovery period for nonresidential real and residential rental property remains at 39 and 27.5 years, respectively.
Computers and Peripheral Equipment Removed from Listed Property. Deductions for such property are no longer subject to the heightened substantiation requirements.
Accounting Simplification for Small Businesses. For certain businesses with not more than $25 million in average annual gross receipts (indexed for inflation), the following accounting simplifications apply:
Accounting Methods/Special Rules for Taxable Year of Inclusion. This provision revises the rules associated with the recognition of income. For taxable years beginning after December 31, 2017, it requires a taxpayer to recognize income no later than the taxable year in which such income is taken into account as income on an applicable financial statement, subject to an exception for certain long-term contract income.
Deferral Method for Advanced Receipts. This codifies the current deferral method of accounting for advance receipts for goods and services under an IRS revenue procedure; i.e., taxpayers will be allowed to defer the inclusion of income associated with certain advance receipts to the end of the taxable year following the tax year of receipt if such income also is deferred for financial statement purposes.
Interest Expense Deduction. For taxable years beginning after December 31, 2017, the deduction for business interest is limited to the sum of business interest income, floor plan financing interest, and 30% of the “adjusted taxable income” of the taxpayer for the taxable year. The adjusted taxable income is the taxable income of the taxpayer computed without regard to (i) any item of income, gain, deduction or loss which is not properly allocable to a trade or business; (ii) any business interest or business interest income; (iii) the 20% deduction for certain pass-through income; (iv) for taxable years beginning after December 31, 2017 and before January 1, 2022 — depreciation, amortization, or depletion; and (iv) the amount of any net operating loss deduction. The amount of disallowed interest is carried forward indefinitely. Exempt from these are businesses with average gross receipts of $25 million or less, regulated public utility companies, electing real property trade or businesses, and electing farming businesses.
Net Operating Loss Deduction. The NOL deduction is limited to 80% of taxable income (determined without regard to the NOL deduction), effective for losses arising in taxable years beginning after December 31, 2017.
Carryovers to other years are adjusted to take account of this limitation and can be carried forward indefinitely. The two-year carryback and certain special carryback provisions are repealed except for certain farming businesses and property and casualty insurance businesses. The provisions to limit carrybacks and allow indefinite carryforwards applies to losses arising in taxable years beginning after December 31, 2017.
Like-Kind Exchanges of Real Property. The like-kind exchange rules are only available for real property not held primarily for sale. The rule is for transfers after 2017 but a transition rule applies to any exchange if either the property being exchanged or received is exchanged or received on or before December 31, 2017.
S Corporation Conversions to C Corporations. In the case of an S corporation which revokes its S corporation election during the two-year period beginning on the enactment date (of this legislation) and has the same owners on both the enactment date and the revocation date, distributions from the terminated S corporation are treated as paid from its accumulated adjustments account and from its earnings and profits. Adjustments attributable to the conversion from S corporation status to a C corporation (IRC Sec. 481(a)) are taken into account ratable over six years.
Repeal of Certain Business Expenses. The following business deductions are repealed:
Local Lobbying Expenses. Deductions for lobbying expenses with respect to legislation before local government bodies are disallowed, effective for amounts paid or incurred on or after the date of enactment.
Amortization of Research and Experimental Expenditures. Specified research or experimental expenditures, including software development expenditures, are capitalized and amortized over a five-year period (15 years if attributable to research conducted outside of the United States). This provision applies on a cut-off basis to expenditures paid or incurred in taxable years beginning after December 31, 2021.
Research and Development Credit. As indicated in Policy Highlights published by the Conference Committee, the credit is preserved.
Modification of Limitation on Excessive Employee Compensation. Applicable to taxable years beginning after December 31, 2017, the exception to the $1 million deduction limitation for commissions and performance-based compensation in the case of publicly held corporations is repealed. The definition of covered employee is amended to include the principal executive officer, the principal financial officer and the three other highest paid employees. Once an employee qualifies as a covered employee, his/her compensation is subject to the $1 million limitations as long as the executive (or beneficiary) receives compensation from the company. There is a transition rule for written binding contracts in effect as of November 2, 2017, not modified thereafter in any material respect.
Denial of Deduction for Settlements Subject to Nondisclosure Agreements Paid In Connection with Sexual Harassment or Sexual Abuse. No deduction is allowed for any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or for attorney’s fees related to such settlement or payment. This provision applies to amounts paid or incurred after the date of enactment.
Deductibility of Fines and Penalties for Federal Income Tax Purpose. No deduction is allowed for any amount paid or incurred to, or at the direction of, a government or governmental entity in relation to the violation of any law or the investigation or inquiry by that government or entity into the potential violation of any law. Certain exceptions apply.