Tax Reform for Businesses
The complete list of changes made to tax laws for businesses is quite extensive, this post will address the more important changes in summary form.
Corporate Tax Rates
Effective January 1, 2018, the corporate income tax rate has been reduced from 35% to 21%. The 21% tax rate is applied to business and investment income of corporations. The corporate alternative tax is also repealed. Corporations with AMT credit carryovers can use the credits for reduce regular tax liability. The net operating loss ("NOL") deduction is limited in general to 80% of taxable income and can only be carried forward (not to prior years). This applies to losses arising in years beginning with 2018. NOLs arising It is interesting to note that our rate is still higher than the UK (19%), Germany (15%) and Canada (15%). The special corporate tax rate on personal service corporations (PSC) has been eliminated, such that the tax rate on a professional service corporation is the same as for other corporations (21%). The dividends received deduction for dividends from corporations has also been changed as follows: 1) the 80% dividends received deduction is lowered to 65% (this applies to owners of at least 20% of a corporation); 2) the 70% dividends received deduction is reduced to 50% (this applies to owners of less than 20% of a corporation).
Depreciation and Expensing
The cost of plant and equipment are deducted over time through depreciation deductions. The new tax reform laws allow for the immediate expensing (termed bonus depreciation) of expenditures for the cost of purchasing plant and equipment. This expensing rule applies to the costs of new and used property acquired by businesses through year 2022, and then phases out over following five years. The rules for expensing depreciable business assets under section 179 have also been modified. Section 179 allows companies to expense the cost of what qualifies as section 179 property up to specific amount. The amount of the section 179 deduction has been increased from $500,000 to $1,000,000. The definition of section 179 property has also been expanded in to include roofs, HVAC property, and other improvements made to nonresidential real property. The depreciation limitations for passenger autos placed in service after 2017 has been increased. These changes apply beginning with tax year 2018. On a negative note, taxpayers must now capitalize, whether than expense, specific research and experimental (R&E) expenditures under section 174 paid or incurred beginning with tax year 2022. The definition of specified R&E expenditures include those for software development.
A limit on the deduction of net business interest expense has been imposed in some circumstances. Section 163(j) has been changed to disallow net business interest expense when in excess of a business's adjusted taxable income plus floor plan financing interest. The deduction under section 199 applicable to domestic production activities has been repealed. Gain or loss on the sale of a self-created patent, invention, model or design, secret formula or process are treated as ordinary and not as a capital asset.
Accrual method taxpayers must recognize income when that income is recognized for financial statement purposes--there are exceptions. Companies will have to coordinate their tax and financial treatment of income. More corporations will be able to use the cash method of accounting, since the limit of the three-year average annual gross receipts has been increased from $5,000,000 to $25,000,000. In addition, businesses with average annual gross receipts of $25,000,000 or less are allowed to use the cash method of accounting, even if they inventory. Also, companies are allowed to use the completed contract method of accounting for long-term contracts if their average annual gross receipts are $25,000,000 or less. This provision applies to contracts entered into beginning with 2018.
The ten-percent credit for pre-1936 buildings is repealed. The twenty-percent credit for certified historic structures has been changed so that it must be claimed over a five-year period. Specific employers are allowed to claim a credit equal to 12.5 percent of the amount of wages paid to qualifying employees if the rate of payment under the program is at least 505 of the wages normally paid to an employee. To be eligible, the employer must allow qualifying full-time employees not less than two weeks of annual paid family and medical leave, and that allows all less-than-full-time qualifying employees not less than two week sof annual paid family and medical leave, and that allows part-time employees leave. This credit for employers is generally effective for wages paid in tax years 2018 through 2019.
Passthrough Entities and Sole Proprietorships
For years beginning with 2018, individual taxpayers are allowed a deduction of 20% of the individual's domestic qualified business income from a sole proprietorship, schedule E rental activity, S corporation or partnership. The deduction is limited to the lesser of the following: a) 50 percent of wages paid; b) 25 percent of W-2 wages plus 2.5% of the unadjusted basis of all qualified property; c) 20 percent of qualified business income. The limitation on 50 percent of wages does not apply in the case of taxpayers with income of $315,000 or less if married filing jointly and $157,500 for other individuals. Qualified business does not include the following services: health, law, accounting actuarial science, performing arts, consulting, athletics, financial services, brokerage services; any trade or business the principal asset of which is the reputation or skill of one or more of its owners or employees; or any business that involves the performance of services that consist of investment and investment managing trading or dealing in securities, partnership interest or commodities. The AICPA (American Institute of CPAs) has recently sent an urgent request to the Internal Revenue Service asking for immediate guidance on the definition of qualified business income for pass-through entities.
Additional information will be forthcoming in posts on our website.
Gene M. Bowman, Attorney and retired CPA, with Bowman Law Firm