Tax reform highlights for businesses

Business owners and executives may need some extra tax-planning time to prepare for changes that the tax-reform bill will bring. These observations are based on an aggregation of news reports.

  • C corporations. Under the agreement, the top corporate tax rate will be permanently reduced to 21 percent effective for tax years beginning after 2017. This is slightly greater than the 20 percent tax rate that was proposed under the House and Senate tax bill. Of significance is the effective date of January 1, 2018, for calendar-year taxpayers, as opposed to 2019, which was the proposal under the Senate bill. This places even more importance on C corporation year-end tax planning to increase deductions in the 2017 taxable year and defer income items into 2018.The agreement calls for a repeal of the Alternative Minimum Tax for C corporations. This is a breath of relief for C corporations after the Senate made a last-minute effort to include corporate AMT before passing its version of the bill.

    In addition, the agreement would limit net operating losses (NOL) created after December 31, 2017, to 80 percent of taxable income. The ability to carryback a NOL for two years would no longer exist for losses created after December 31, 2017. Instead, the current ability to carryforward a NOL for 20 years would be expanded to allow a net operating loss to be carried forward indefinitely for losses arising after December 31, 2017. The reduction in the corporate tax rate, coupled with the change in net operating loss rules, provides corporations with a significant incentive to accelerate deductions in 2017 and defer income to 2018.

  • Pass-through entities. The Senate proposal was supported in the agreement, allowing a 20 percent deduction for qualified business income from a partnership, S corporation or sole proprietorship. This is a slight decrease from the 23 percent deduction originally proposed by the Senate. The agreement also provides that trusts and estates are eligible for the deduction.The deduction is subject to a potential 50 percent W-2 wage limitation and is disallowed for certain services businesses. However, the W-2 limitation and the exclusion of service businesses could be avoided if a taxpayer’s taxable income does not exceed $315,000 for married filing joint returns, or $157,500 for single filers.
  • Limitation on interest expense. A proposed law that affects both C corporations and pass-through entities relates to the limitation on business interest expense. While both the House and Senate proposals agreed on limiting net interest expense to 30 percent of a business’s adjusted taxable income, they varied on how they defined adjusted taxable income. The Senate wanted to define adjusted taxable income as earnings before income tax (EBIT), while the House defined it as earnings before income tax, depreciation, and amortization (EBITDA), thereby resulting in a larger number and less of a limitation. The compromise that was reached under the agreement limits the deduction for net business interest expense by allowing 30 percent of EBITDA for five years, then 30 percent of EBIT thereafter. Any disallowed interest would be carried forward indefinitely. In addition, the agreement would exempt taxpayers from the limitation if their average gross receipts for the prior three taxable-year periods did not exceed $25 million.
  • Cost recovery. The agreement allows for full (100 percent) expensing for property placed in service after September 27, 2017, and before January 1, 2023. The amount of expensing would be phased-down 20 percent each year between January 1, 2023, and January 1, 2027. In addition, the definition of qualified property has been expanded to not only include new property but also used. Taxpayers will also be allowed to elect 50 percent bonus depreciation instead of full expensing for qualified property placed in service during the first tax year ending after September 27, 2017. Careful consideration should occur in relation to the potential to fully expense assets purchased between September 27, 2017, and December 31, 2017, in conjunction with the fact that net operating losses generated prior to December 31, 2017, will not be limited to 80 percent of taxable income.The Agreement would also increase the IRC Section 179 amount to $1 million, and the phase-out would not begin until $2.5 million of Section 179 property was placed into service.

Most business tax reform proposals are now slated to be effective for 2018. We encourage you to work with your tax advisor this month to discuss planning techniques.

Author Acknowledgement: Our special thanks to Lynn Mucenski-Keck of The Bonadio Group for providing the above article.