By: Chris Lambert, CPA, CGMA, CCIFP, Bruce Lawson, CPA, PFS, and Danny Shobe, CPA, CGMA, CCIFP
The recently enacted Tax Cuts and Jobs Act (TCJA) has altered the tax landscape for many businesses. The changes are extensive, and this letter provides a high-level overview of some of the highlights to keep you informed. Due to the sweeping nature of the changes and the need for continued guidance, we’d like the opportunity to have a personalized conversation with you now to discuss planning opportunities for your specific situation. Additional discussions and tax projections are likely necessary to ensure we maximize your tax benefits.
The new tax code contains many provisions that will affect individual, estate, and corporate taxpayers. To help you prepare, we have highlighted a few of the most pertinent details below. Please keep in mind, the purpose of this article is to summarize the key provisions.
Corporate Changes
The new corporate tax rate
The prior-law graduated corporate tax rates have been consolidated into one 21% flat rate. The separate rate for personal service corporations of 35% has been repealed. These new rates are effective for tax years beginning after December 31, 2017. Fiscal-year corporations will use a blended rate based on the number of months at the old versus the new rate structure.
Alternative minimum tax (AMT) repeal
The TCJA has repealed the corporate AMT.
Bonus depreciation and Sec. 179 expensing of fixed assets
Bonus depreciation and Sec.179 expensing of property have been available in varying amounts for quite a while. The new tax law has increased the bonus depreciation percentage to 100% until 2023, where it will decrease by 20% until it reaches zero. Bonus depreciation now applies to both new and used qualified property. The Sec.179 expense limit is now $1 million of allowable expensing with a total purchase threshold of $2.5 million. Your allowable expense limit will lower if you purchase more than $2.5 million in eligible fixed assets during the taxable year.
The higher limits and expansion in the definition of property that qualifies for these deductions allow for tax planning opportunities. As part of your planning, we’d like to understand your asset purchasing behavior and plans for the future so we can help you maximize these deductions.
Net operating losses (NOLs)
Under the prior tax law, NOLs could be carried back two years or carried forward for 20 years. Unfortunately, the TCJA repealed the ability to carry back an NOL and claim a refund for already-paid taxes, effective for tax years starting after Dec. 31, 2017.
Interest expense deductibility
The TCJA introduced a limit in the deductibility of business interest to 30% of taxable income. The taxable income limitation is usually calculated without regard to allowable deductions for items such as depreciation, amortization, or depletion.
This limitation does not apply to taxpayers with gross receipts of $25 million or less. If your gross revenues exceed $25 million, we recommend having a discussion with us about the impact on your business. Regardless, with careful planning, we can help you maximize your deduction.
Like-kind exchange restrictions
The new tax law restricts a like-kind exchange to real property (e.g., buildings and land). Under the prior law, you could utilize a like-kind exchange for tangible personal property (e.g., cars and trucks) and intangible property used in a business or held for investment. Be aware of this change and contact us so we can help you plan accordingly.
Cash Basis Method of Accounting
For tax years beginning after December 31, 2017, the cash method of accounting may be used by taxpayers that have average annual gross receipts for the previous three tax years under $25 million. The $25 million threshold will be indexed for inflation beginning for years after December 31, 2018.
Accounting for Long-Term Contracts
Contractors may be exempt from using the percentage of completion method for recognizing income if the following two scenarios are met:
1) the contract is completed within two years from the time it is commenced, and
2) the taxpayer performing the contract average annual gross receipts for the three preceding tax years is less than $25 million.
Changes to Fringe Benefits, Entertainment Expenses
The elimination of a business-related deduction used for entertainment, amusement or recreation expenses, will make it costlier for business owners to entertain clients.
Previously, if an entertainment or meal expense was related to or associated with the active conduct of a trade or business, it was deductible up to 50 percent. Under the new tax code, these expenses are now considered the cost of doing business. In the chart below, we have highlighted the significant changes:
|
Activity |
2017 Old Rules |
2018 New Rules |
| Qualified client meal expenses | 50% deductible | 50% deductible |
| Qualified employee meal expenses | 50% deductible | 50% deductible |
| Meals provided for employer convenience | 100% deductible | 50% deductible |
| Client entertainment expenses | 50% deductible | No deduction for entertainment expenses |
| Event tickets | 50% deductible at face value of ticket | No deduction for entertainment expenses |
| Qualified charitable events | 100% deductible | No deduction for entertainment expenses |
| Office holiday parties | 100% deductible | 100% deductible |
The elimination of this deduction will impact business owners who are accustomed to treating clients to golf outings or providing clients with tickets to sporting events or concerts. Businesses will have to re-evaluate their entertainment expenses related to their trade or business, as these items are no longer 50 percent deductible.
In consideration of the elimination of this deduction, we recommend creating separate accounts for meals and entertainment expenses. Educating employees to separate their expenses will be vital as business meals will remain 50 percent deductible until 2025.
Auditors notoriously target entertainment expenses and we anticipate these expenses to be even more of a heightened area of concern during an audit. The professionals in our office can help ensure you comply, call us today.
Navigating the New Qualified Business Income Deduction (QBI)
Another change that will impact individual and estate business owners is the Qualified Business Income Deduction. QBI is a new tax benefit allowing entrepreneurs, self-employed individuals and investors to deduct 20 percent of their business income before calculating taxable income. It is an essential factor to consider when deciding whether the structure of your business will be a pass-through entity or a C Corporation. In this article, we will explain how the deduction works.
A word of caution: This is one of the most complex changes that was made in the Tax Act and there is significant guidance expected before year end. There are many areas that need further clarification from the IRS. Accordingly, if QBI applies to you and your business, please know that we will be monitoring the guidance and updating as appropriate.
What is QBI and how does it work?
QBI is business income passed through from a sole proprietorship, S Corporation, or partnership. It does not include wages earned as an employee. In its most simple form, the QBI deduction permits eligible taxpayers to deduct 20 percent of their qualified business income from their taxable income. It is considered a “below-the-line” deduction, meaning it does not reduce your adjusted gross income. The deduction is available for tax years beginning after December 31, 2017, and before January 1, 2026. There is speculation whether a future Congress will uphold individual provisions.
Qualified Business Income Deduction Eligibility
Eligible Non-Eligible
Trust and estates C Corporations
Individuals Employee Wages
Partnership
S Corporation
Sole Proprietor
There are a few steps, rules, and thresholds that have to be evaluated before you are finally determined to be entitled to the deduction.
- If your business is not a “specified service” business, and your taxable income is less than $315k (MFJ), the deduction is simply 20% of the net income passed out and reported on your personal income tax return.
- If your taxable income is greater than $315k (MFJ), there is a second threshold to calculate involving W2 wages of the business and unadjusted basis of fixed assets. If the 20% is less than 50% of the W2 wages, then you will get the deduction in full. If it is more than 50% of the W2 wages, there is a second threshold of 25% of W2 wages plus 2.5% of the unadjusted basis of qualified fixed assets.
- If your business is a “specified service”, the calculation has different tests/thresholds. A Specified Service Trade or Business (SSTB) is any trade or business that involves the performance of services and include the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, trades or businesses involving investing and investment management, or any trade or business “where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees”.
- If your taxable income is less than $315k (MFJ), then you are entitled to the 20% deduction in full.
- If your taxable income is between $315k and $415k (MFJ), then there is a phase-out of the 20% deduction.
- If your business income involves architecture, engineering, insurance, financing, leasing, or hotel/motels, it is excluded from the “specified service” definition.
Some examples that might be helpful are:
Scenario A – Your business is not considered a specified service trade or business and is above the threshold
In the instance that a taxpayer earns more, the deduction is limited to 50 percent of the W-2 wages paid by the business or 25 percent of the W-2 wages paid by the business plus 2.5 percent of the unadjusted basis of all qualified property, whichever is greater.
Scenario B – Your business is considered a specified service trade or business and is below the threshold
If you are considered a specified service business and your income is below the threshold, you can still take advantage of the QBI deduction as long as your taxable income falls below $315,000 (married filing jointly), $207,500 (head of household), or $157,500 (single filers). Engineers and architects are specifically exempted from being categorized as an SSTB.
Scenario C – Your business is considered a specified service trade or business and is above the threshold
If you are considered a specified service business and your income is above the threshold, the QBI 20% deduction is gradually reduced over the next $100,000 (married filing jointly) or $50,000 (for all other filing statuses) of taxable income above the threshold. The QBI deduction is $0 if you are married filing jointly with taxable income at or above $415,000 or $207,500 for all other filing statuses.
The QBI deduction is a new concept that is based on some older IRS Code sections that were not written to fully define several of the key concepts used in this new area. Accordingly, we are expecting significant further guidance and explanations to be issued by the IRS before year end. Based on what we expect and what the commentators are predicting, there will still be significant planning opportunities in this arena.
Other Miscellaneous Individual/Estate Changes
Standard Deduction – The standard deduction has nearly doubled. For single filers it has increased from $6,350 to $12,000; for married couples filing jointly, it’s increased from $12,700 to $24,000.
State and Local Tax Deduction – The state and local tax deduction, or SALT, now has a cap. While it remains in place for those who use itemized deductions, it now has a $10,000 limit. This is a significant change as filers could previously deduct an unlimited amount for state and local property taxes, plus income or sales taxes.
Estate Tax – Before the tax reform, a limited number of estates were subject to the estate tax, a tax which applies to the transfer of property after someone dies. Now, even fewer taxpayers will be affected. The previous exclusions were $5.49 million for individuals, and at $10.98 million for married couples. Those amounts have been doubled to $11.180 million for individuals and $22.360 million for married couples. The new gift limit for 2018 is $15,000.
Personal Exemption – Under the prior tax code, a taxpayer could claim a $4,050 personal exemption for themselves, their spouse and each of their dependents, thus lowering their taxable income. Under the new tax code, the personal exemption has been eliminated. For some families, this will reduce or counter the tax relief they receive from other parts of the reform package.
The Child Tax Credit – The child tax credit has been expanded, doubling to $2,000 for children under 17. It’s also available to more people. Single parents who make up to $200,000 and married couples who make up to $400,000 can claim the entire credit, in full.
Tax Bracket Rates – While taxpayers will still fall into one of seven tax brackets based on their income, the rates have changed. See the table below to see how the brackets changes for the filing statuses of Married Filing Joint and Single
|
Married Filing Jointly – New and Old Rate Comparison |
|||
|
New 2018 Rate |
New 2018 Taxable Income Bracket |
Old 2017 Rate |
Old 2017 Taxable Income Bracket |
|
10% |
Up to $19,050 |
10% |
Up to $18,650 |
|
12% |
$19,050 – $77,400 |
15% |
$18,650 – $75,900 |
|
22% |
$77,400 – $165,000 |
25% |
$75,900 – $153,100 |
|
24% |
$165,000 – $315,000 |
28% |
$153,100 – $233,350 |
|
32% |
$315,000 – $400,000 |
33% |
$233,350 – $416,700 |
|
35% |
$400,000 – $600,000 |
35% |
$416,700 – $470,700 |
|
37% |
$600,000+ |
39.6% |
$470,700+ |
|
Single – New and Old Rate Comparison |
|||
|
New 2018 Rate |
New 2018 Taxable Income Bracket |
Old 2017 Rate |
Old 2017 Taxable Income Bracket |
|
10% |
Up to $9,525 |
10% |
Up to $9,325 |
|
12% |
$9,525 – $38,700 |
15% |
$9,325 – $37,950 |
|
22% |
$38,700 – $82,500 |
25% |
$37,950 – $91,900 |
|
24% |
$82,500 – $157,500 |
28% |
$91,900 – $191,650 |
|
32% |
$157,500 – $200,000 |
33% |
$191,650 – $416,700 |
|
35% |
$200,000 – $500,000 |
35% |
$416,700 – $418,400 |
|
37% |
$500,000+ |
39.6% |
$418,400+ |
|
|
|
|
|
Alternative Minimum Tax – Fewer taxpayers will be affected by the alternative minimum tax. The purpose of the AMT is to ensure those who receive many tax breaks are still paying some level of federal income taxes. The exemption will rise to $70,300 for singles, and to $109,400 for married couples.
Mortgage Interest Deduction – Anyone purchasing a home will only be able to deduct interest paid on the first $750,000 of their mortgage debt. Down from $1 million, this will likely only affect people buying homes in more expensive regions. Current homeowners should be unaffected, unless they refinance their mortgages for more than the amount outstanding immediately prior to refinancing. The TCJA also eliminated the interest deduction from home equity loans unless the home equity loan is used for acquisition indebtedness or home improvements.
Disaster Deduction – Under the prior tax code, losses sustained due to a fire, storm, shipwreck or theft that insurance did not cover and exceeded 10% of their adjusted gross income, were deductible. Effective under the new tax code, taxpayers can only claim the disaster deduction if they are affected by a presidentially declared national disaster.
Health Insurance Mandate – The failure to repeal Obamacare earlier this year afforded the Republicans the opportunity to eliminate one of the health law’s key provisions with tax reform. Effective in 2019, the individual mandate, which penalized people who did not have health care coverage, was eliminated.
What’s Staying the Same?
Student Loan Interest – You can still deduct Student Loan Interest – the deduction for this will remain at a max $2,500.
Medical Expenses – The deduction for medical expense was expanded to allow filers the ability to deduct medical expenses that exceed 7.5% of their adjusted gross income for another two years.
Teachers – Teachers will continue to deduct up to $250 to offset what they spend on resources for the classroom.
Home Sellers – Homeowners that sell their house and make a profit can exclude up to $500,000 (or $250,000 for single filers) from capital gains. This still requires that it is their principle residence and they have lived there for at least two of the past five years.
Conclusion
Conclusion is really a misleading heading, as we expect more IRS guidance on many of these changes. Some are pretty cut and dry, but there are areas such as QBI that will continue to evolve.
As always, we are available to discuss any and all of these issues. Please give us a call or send an email. We would love to talk about your specific situation and begin planning now.
Chris Lambert, CPA, CGMA, CCIFP
CSLambert@suttlecpas.com
304-720-3102
Bruce Lawson, CPA, PFS
BLawson@suttlecpas.com
304-720-3132
Danny Shobe, CPA, CGMA, CCIFP
DShobe@suttlecpas.com
304-720-3131