The Tax Cuts and Jobs Act (“TCJA”), a $1.5 trillion tax cut package, was signed into law on December 22, 2017. Last month, I focused on the individual implications of this historic reform package. Now, let’s dive into the details for businesses. Major provisions are summarized below and take effect in the 2018 tax year unless otherwise stated.
Corporate tax rates
· The new legislation establishes a single flat corporate rate of 21% and abolishes the previous graduated tax brackets of 15%, 25%, 34%, and 35%.
· TCJA permanently repeals the corporate alternative minimum tax (“AMT”).
Pass-through business income deduction
If you are a sole proprietor or partner who receives business income from a pass-through entity, you typically report that business income on your individual income tax return, paying tax at individual rates. For tax years 2018 through 2025, a new deduction is available. The deduction equals 20% of qualified business income from partnerships, S corporations, sole proprietorships, and LLCs that are not taxed as C Corporations.
Thresholds and Caveats
Be careful, though. If taxable income on your personal tax return exceeds certain thresholds, your deduction may be limited or phased out entirely. If you’re single with taxable income below $157,500 (or $315,000 if married filing jointly), the 20% pass-through deduction amount can be claimed. Single filers with taxable incomes between $157,500 and $207,500 (or between $315,000 and $415,000 if married filing jointly) may be able to claim a partial deduction.
If you are above those taxable income thresholds, two caveats apply:
· The deduction is generally limited to the greater of: 50% of the W-2 wages reported by the business, OR 25% of the W-2 wages plus 2.5% of the value of qualifying depreciable property held and used by the business to produce income. This especially benefits real estate owners and other capital-intensive businesses.
· The deduction is completely disallowed for businesses that involve the performance of services. This disallowance pertains to industries such as: health, law, accounting, actuarial science, performing arts, consulting, athletics, and financial services.
Taxable income doesn’t simply mean income from the business. Imagine this scenario: you are single and your pass-through business income as a consultant is $140,000. Your investment and other income totals $35,000. Combined, that is $175,000. You take the standard deduction of $12,000 but have no other deductions. You’re above the $157,500 threshold at $163,000 ($175K minus $12K), so the two caveats apply. Since you are in the disallowed field of consulting, you won’t get any pass-through business deduction.
Now, for a different example. Your tax status is married filing jointly. You and your spouse together have taxable income of $300,000. Even if you’re in a service-based business, you can take the full pass-through business deduction of 20% because you’re below the $315,000 income threshold. (2/15/18 Addition: For more specific rules and examples on the pass-through business deduction, consult this article by Michael Kitces.)
The cost of tangible property used in a trade or business usually must be recovered through annual depreciation deductions. For most qualified property acquired and placed in service before 2020, special rules allowed an up-front additional "bonus" amount to be deducted. For property placed in service in 2017, the additional first-year depreciation amount was 50% of the adjusted basis of the property.
TCJA extends and expands first-year additional ("bonus") depreciation rules. Bonus depreciation is extended to cover qualified property placed in service before January 1, 2027. For qualified property that's both acquired and placed in service after September 27, 2017, 100% of the adjusted basis of the property can be deducted in the year the property is first placed in service. The first-year 100% bonus depreciation percentage amount is reduced by 20% each year starting in 2023 (i.e., the first-year bonus percentage amount will be 80% in 2023, 60% in 2024, and so on) until bonus depreciation is eliminated entirely in 2027.
For qualified property acquired before September 27, 2017, prior bonus depreciation limits apply — if placed in service in 2017, a 50% limit applies. The timelines and percentages are slightly different for certain aircraft and property with longer production periods.
Internal Revenue Code (IRC) Section 179 expensing
Small businesses may elect under IRC Section 179 to expense the cost of qualified property, rather than recover such costs through depreciation deductions. The Act increases the maximum amount that can be expensed in 2018 from $520,000 to $1 million. The threshold at which the maximum deduction begins to phase out has also increased from $2,070,000 to $2.5 million. The new law also expands the range of property eligible for expensing.
Under pre-existing corporate tax rules, U.S. companies were taxed on worldwide profits, with a credit available for foreign taxes paid. If a U.S. corporation earned profit through a foreign subsidiary, no U.S. tax was typically due until the earnings were returned to the United States (generally in the form of dividends paid). Accordingly, some domestic corporations moved production overseas and multinational companies often kept profits outside the U.S.
The new law fundamentally changes the way multinational companies are taxed, making a shift from worldwide taxation of income to a more territorial approach. Under the new rules, qualifying dividends from foreign subsidiaries are effectively exempted from U.S. tax. The new law also forces corporations to pay U.S. tax on prior-year foreign earnings that have accumulated outside the United States in foreign subsidiaries, through a one-time "deemed repatriation" of the accumulated foreign earnings. The one-time tax is not limited to C corporations; it can apply to all U.S. shareholders, including individuals (special rules apply to S corporations and REITs). After paying the one-time deemed repatriation tax, foreign earnings can be brought back to the United States without paying any additional tax. This encourages 10% shareholders of foreign corporations to bring production back to the U.S. and stimulate our domestic economy.
The key provision impacting most small business owners is the 20% pass-through business income deduction. You may benefit from other changes affecting larger corporations and capital-intensive businesses but should probably rely on a trusted CPA to interpret those rules. In addition to running WorthyNest, I own SV CPA Services. If you need assistance with 2017 tax filings or have questions about the new 2018 tax rules, please reach out.
Deborah L. Meyer, CPA/PFS, CFP®