The Tax Cuts and Jobs Act of 2017 (TCJA) contains many changes that will affect business and personal income taxes beginning in fiscal 2018. The TCJA is the most substantial change to the U.S. tax system since the Tax Reform Act of 1986. It is important to review the significant changes now for tax planning and to prepare for April filings.
Here’s an overview of many of the substantial changes that are relevant for businesses, including changes for C-corporations, flow-through entities (S-corporations, partnerships and limited-liability companies (LLCs)), and their owners.
Corporate tax rate: The C-corporation income tax rate is now a flat 21 percent. For companies with substantial income, this is a significant savings over the previous rates.
Corporate alternative minimum tax (AMT): C-corporations are no longer subject to AMT.
Tax accounting methods: Many businesses are now eligible to use the cash-basis method of accounting, capitalize only nonincidental materials and supplies to inventory, and are not subject to the UNICAP 263A inventory tax adjustment.
Most businesses with less than $25 million of average gross receipts are eligible. For most businesses, these accounting method changes will result in a substantial deferral of taxable income.
Accelerated depreciation: Most fixed asset additions are eligible for 100 percent bonus depreciation expensing. Now, even most used property qualifies for bonus depreciation. Section 179 depreciation can be taken on up to $1 million of additions, with certain limitations. If you plan to make substantial investments in equipment, consider doing so before year-end to get the tax deduction this year.
Net operating losses: C-corporation losses can no longer be carried back to offset prior year taxes. Instead, they carry forward indefinitely and can offset up to 80 percent of taxable income each year Net operating loss carried forward from years prior to 2018 can offset up to 100 percent of taxable income each year.
Business interest expense: The business interest expense deduction is limited to 30 percent of business income before interest, tax, depreciation and amortization. Businesses with less than $25 million of average gross receipts are not subject to this limitation.
Disallowed interest expense is carried forward to subsequent years and is deductible, subject to the same limitations. Affected businesses should evaluate options to decrease interest expense. In certain situations, there is a tax benefit to replace debt with equity.
Meals and entertainment: There are now more strict limitations on the deductibility of meals and entertainment.
Entertainment is non-deductible. Employee meals provided for the benefit of the employer are 50 percent deductible. Business meals are 50 percent deductible, unless lavish.
Business meals that are considered lavish by the IRS are treated as non-deductible entertainment. Company recreational and social activities for employees, such as holiday parties, birthdays, anniversary celebrations and company picnics, continue to be 100 percent deductible. New expense accounts can be set up now to track these expenses.
Employee expense reimbursement: Employees are no longer able to deduct unreimbursed business expenses on their personal taxes. Companies should consider if it makes business sense to revise expense-reimbursement policies.
20 percent pass-through deduction: Individuals can deduct up to 20 percent of qualified business income on their personal taxes, subject to limitations. For higher income individuals, this is limited to the greater of 50 percent of business wages or 25 percent of business wages and 2.5 percent of the cost of certain fixed assets. Qualified income can be from partnerships, S-corporations, and sole proprietorships. There are limitations on what type of income qualifies.
Nicholas Biller is a tax director at BPM. He can be reached at NBiller@bpmcpa.com.