It has been almost a year since the President signed the Tax Cuts and Jobs Act of 2017 (the “TCJA”) into law. The TCJA contained the most wide-sweeping changes to U.S. tax law in over 30 years. The vast majority of these changes went into effect January 1st of 2018. While many traditional tax planning strategies are still available, the TCJA has added some new twists and turns that may factor into your tax planning for year-end 2018 and heading into 2019.
Always consult with your tax advisor for special rules and assistance before implementing any tax planning strategies.
Please be advised that while the IRS has already come out with proposed regulations interpreting many of the TCJA changes, we are still awaiting final regulations on some topics and additional guidance on others.
Individual Tax Planning:
Highlighted Tax Planning Opportunities for Individuals to consider before December 31, 2018:
Income Deferral: Even though tax rates have come down across the board in 2018, many taxpayers may benefit from pushing some income recognition back to 2019 or later to the extent possible.
Deferring taxable gains from the sale of stocks or assets with gains may be advantageous. Tax-loss harvesting can also be an effective tool for sheltering realized gains in 2018, thereby reducing taxable net capital gains this year.
Section 1031 (like-kind exchanges) is still available for certain taxpayers wishing to roll gains into qualified replacement property, but only certain real estate qualifies for this starting in 2018.
Qualified Opportunity Zone Funds: A new incentive for deferring and potentially avoiding up to 15% of taxable gains arose under the TCJA, called Qualified Opportunity Zones. Taxpayers who contribute gains from taxable sales of stocks or other assets within 180 days into a Qualified Opportunity Fund (QOF) may be able to defer tax on that gain for up to 7 years and reduce that deferred taxable gain up to 15% in some cases, while also avoiding taxable gains inside the fund if held for at least 10 years. QOFs are required to hold at least 90% of their assets within Opportunity Zone areas approved by the government. Taxpayers with large 2018 realized gains may wish to explore this option soon, as many of these funds are being formed to accommodate investors. Investment in these funds could possibly occur in 2019 and still qualify for 2018 gain deferral if done within 180 days of the realized gain date.
Acceleration of Deductions into 2018: Many deductions that were available in the past have gone away or been capped (Miscellaneous Itemized Deductions, State and Local Income Taxes Capped at $10,000, Restrictions on Mortgage Interest Deduction). Also, if you are married filing jointly, then your itemized deductions need to be over $24,000 in total to get any benefit from itemizing. If you are single, then you would need to have over $12,000 to receive any benefit from itemizing. So for some taxpayers now, bunching of itemized deductions into tax years when they are likely to exceed these standard deductions might make sense where possible.
Medical deductions remain in effect under the TCJA, but with a 7.5% of Adjusted Gross Income (“AGI”) floor for all taxpayers now. So the acceleration of medical deductions into 2018 may benefit some taxpayers with large deduction amounts relative to their AGI.
Charitable Contributions are still deductible, up to 60% of AGI for cash contributions to public charities, increased from 50% under the prior law. The same AGI limitation of 30% applies to donations of long-term capital gain property to public charities as before, and qualified conservation easements are still subject to a 50% AGI limit. However, donations to colleges for athletic seating rights are no longer tax-deductible.
Speaking of Charitable Contributions, the Qualified Charitable Distribution rule up to $100,000 per year for IRA required minimum distributions (“RMDs”) remains in effect as it was under prior law and may be a useful way to fund charitable contributions while minimizing AGI, which can offer tax savings for some taxpayers, versus taking those charitable contributions as itemized deductions.
Accelerating Income into 2018. Depending on your projected income for 2018, it may make sense to accelerate income into 2018 if you expect 2019 income to be significantly higher because of increased income or substantially decreased deductions, potentially pushing you into a higher marginal tax bracket in 2019. Some ideas for accelerating income include: (1) harvesting gains from your investment portfolio or other taxable assets, keeping in mind the 3.8 percent NIIT; (2) doing regular-to-Roth IRA conversions this year; (3) taking IRA distributions this year rather than next year; (4) if you are a self-employed, cash-basis taxpayer and have receivables on hand, encouraging customers or clients to pay them before year-end; and (5) settling any outstanding lawsuits or insurance claims that will generate income this year.
Deferring Deductions into 2019. If you anticipate a substantial increase in taxable income next year pushing you into a higher tax bracket, it may be advantageous to push deductions back into 2019 by: (1) postponing year-end charitable contributions, property tax payments, and medical and dental expense payments, to the extent deductions are available for such payments, until next year; and (2) postponing the sale of any loss-generating property.
Required Minimum Distributions: For those of you who reached the age of 70½ in 2018 and now must take a Required Minimum Distribution (RMD), you have until April 1st of 2019 to take that first RMD. Depending on how much the RMD is supposed to be, it may be advisable to optimize the timing of this first RMD with your CPA. The RMD may push you into a higher tax bracket in 2019 based on your circumstances, so that taking some or all of your first RMD in 2018 might make more sense.
Retirement Contributions: If you have not maxed out your eligible retirement plan contributions, some have a December 31, 2018 deadline.
- Taxpayers have until December 31st to max out their 401(k) deferrals up to $18,500, or if at least age 50 up to $24,500, in order to reduce 2018 taxable wages.
- For those who are Self-Employed, then you may be able to contribute up to $55,000 into a SEP IRA for 2018, or if at least age 50 up to $61,000. These amounts can be funded as late as the extended due date of your 2018 tax returns.
- You have until the Tax Filing Deadline (April 15th) to fund 2018 IRA contributions up to $5,500, or if at least age 50 up to $6,500.
- There is also a potential low-income Saver’s Credit of up to $1,000 for Single filers or $2,000 for those Married Filing Jointly for contributing to a retirement plan.
Lifetime Learning Credit and American Opportunity Credit: If you have been thinking about taking a class in 2019 to improve or boost your career, then pay for the class by December 31st for classes in the first quarter of 2019 and possibly be able to take the Lifetime Learning Credit of up to $2,000 per return.
If you have a college student, it may also work to pay first quarter 2019’s tuition by December 31st and you may be able to pick up the American Opportunity Tax Credit of up to $2,500 for the first four years of college.
Flexible Spending Accounts: If you have an FSA (Flexible Spending Account), then you may have already been saving taxes due to benefits being taken out pre-tax. However, most FSAs are subject to the “Use It or Lose It” rule. If you have not used all the money in your FSA by the end of the year, then you may very well lose it. Check with your employer to see if they have adopted a grace period that is allowed by the IRS. If so, then you may have until March 15, 2019 to use the money. If not, then consider using up any remaining funds this year.
Health Savings Accounts: Taxpayers with qualifying high-deductible health insurance plans are still allowed to fund HSAs (Health Savings Accounts) up to $3,450 for single coverage and up to $6,900 for family coverage. Taxpayers at least age 55 are allowed to contribute an extra $1,000 if they wish. These contributions can be made as late as April 15, 2019 and be deducted for 2018.
Divorce Timing: The TCJA suspended the ability to deduct alimony paid and the inclusion in income of alimony received for Divorce or Separation Agreements executed after December 31, 2018. This also includes a Divorce or Separation Agreement executed before that date but modified after that date if the modification expressly provides that this new provision applies to such modification. Likely alimony payers may wish to accelerate a divorce proceeding this year to preserve the deduction ability in future years when paid, while alimony recipients may wish to stall divorce proceedings till next year.
Life Events: Did anything change in your life during 2018? Did you get married, separated, or divorced? Did you have a child? Did you adopt? Did you buy a house? All of these have potential tax consequences, both good and bad, and should be discussed with your CPA.
Vacation Home Rentals: If you rent out a vacation home that you also use for personal purposes, it may be wise to review the number of days it was used for business versus personal to see if there are ways to maximize tax savings with respect to that property.
In Case You Missed It
Here are some of the changes that are impacting your 2018 Taxes, in case you missed them.
Tax rates: The new law imposes a new tax rate structure with seven tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The top rate was reduced from 39.6% to 37% and applies to taxable income above $500,000 for single taxpayers, and $600,000 for married couples filing jointly. No change to capital gains and qualified dividends rates. “Kiddie Tax” rules were simplified and are no longer affected by the parent’s tax situation or unearned income of siblings. The Kiddie Tax now is based on trust and estate tax rate schedules.
Standard deduction: The new law increases the standard deduction to $24,000 for joint filers, $18,000 for heads of household, and $12,000 for singles and married taxpayers filing separately. Given these increases, many taxpayers will no longer be itemizing deductions. These figures will be indexed for inflation after 2018.
Exemptions: The new law suspends the deduction for personal exemptions. Thus, starting in 2018, taxpayers can no longer claim personal or dependency exemptions for federal tax purposes.
Child and family tax credit: The new law increases the credit for qualifying children (i.e., children under 17) to $2,000 from $1,000, and increases to $1,400 the refundable portion of the credit. It also introduces a new (nonrefundable) $500 credit for a taxpayer’s dependents who are not qualifying children. The adjusted gross income level at which the credits begin to be phased out has been increased to $200,000 ($400,000 for joint filers).
State and local taxes: The itemized deduction for state and local income and property taxes is limited to a total of $10,000 starting in 2018.
Mortgage interest: Under the new law, mortgage interest on loans used to acquire a principal residence and a second home is only deductible on debt up to $750,000 (down from $1 million), starting with loans taken out in 2018. And there is no longer any deduction for interest on home equity debt not used for purchase or improvement of a principal or second home, regardless of when the debt was incurred.
Miscellaneous itemized deductions: There is no longer a deduction for miscellaneous itemized deductions, which were formerly deductible to the extent they exceeded 2 percent of adjusted gross income. This category included items such as certain investment expenses, tax preparation costs, union dues, and unreimbursed employee expenses.
Medical expenses: Under the new law, for 2017 and 2018 medical expenses are deductible to the extent they exceed 7.5 percent of adjusted gross income for all taxpayers. Previously, the AGI “floor” was 10% for most taxpayers.
Casualty and theft losses: The itemized deduction for casualty and theft losses has been suspended except for losses incurred in a federally-declared disaster.
Overall limitation on itemized deductions: The new law suspends the overall limitation on itemized deductions that formerly applied to taxpayers whose adjusted gross income exceeded specified thresholds, often referred to as the Pease limitation. Under prior law, the itemized deductions of such taxpayers were reduced by 3% of the amount by which AGI exceeded the applicable threshold, but the reduction could not exceed 80% of the total itemized deductions, and certain items were exempt from the limitation.
Moving expenses: The deduction for job-related moving expenses have been eliminated, except for certain military personnel. The exclusion for moving expense reimbursements has also been suspended.
Health care “individual mandate:” Starting in 2019, there is no longer a penalty for individuals who fail to obtain minimum essential health coverage.
Estate and gift tax exemption: Effective for decedents dying, and gifts made, in 2018, the estate and gift tax exemption has been increased to roughly $11.2 million ($22.4 million for married couples).
Alternative minimum tax (AMT) exemption: The AMT has been retained for individuals by the new law, but the exemption has been increased to $109,400 for joint filers ($54,700 for married taxpayers filing separately), and $70,300 for unmarried taxpayers. The exemption is phased out for taxpayers with alternative minimum taxable income over $1 million for joint filers, and over $500,000 for all others.
Business Tax Planning
The TCJA has potentially huge impacts on how businesses ranging from Sole-Proprietorships to Partnerships, S-Corporations, and C-Corporations are now taxed. The biggest impacts are likely to result from the reduction of the C-Corporation Tax Rate down to a flat 21% and the Section 199A 20% Qualified Business Income deduction for certain sole proprietorships and pass-through entities. Many of these changes have complicated rules and formulas that need to be applied and should be discussed with your CPA.
Highlighted Tax Planning Opportunities for Businesses to consider before December 31, 2018:
Increased Expensing and Bonus Depreciation: The increased Code Sec. 179 expensing deduction and the increased bonus depreciation deduction may create new opportunities to reduce current year tax liabilities through the acquisition and placement in service by December 31, 2018 of qualifying property. However, if you have expiring net operating losses, then holding off on such purchases until next year or later, or electing out of Sec. 179 or bonus depreciation may be a more beneficial for some taxpayers.
Tax Entity Optimization (Reduced 21% C-Corporation Tax Rate vs. the New 20% Sec. 199A Qualified Business Income Deduction): As a result of the change to corporate tax rates and the introduction of a new sole proprietorship and pass-thru entity deduction, some businesses may want to rethink their choice of entity. A reduction in the corporate tax rate from a 35% rate on income in the highest bracket to a flat 21% rate may appeal to some taxpayers, generally those with no state tax exposure and/or businesses that tend to retain net profits and not flush out as dividends or compensation, while the 20% Section 199A deduction for certain sole proprietorships and pass-through entities may be more beneficial to others for now. It should be noted, however, that C-Corporations with less than $50,000 of taxable income were previously only subject to a 15% federal marginal tax rate. Those businesses will generally wind up paying more tax under the new law.
One key point to remember is that the 21% tax rate is “permanent”, at least until Congress changes it (tax law is never really permanent), while the 20% Section 199A deduction for certain sole proprietors and pass-through businesses is scheduled to expire after 2025.
Additionally, the 20% Section 199A deduction does not fully apply to many types of businesses referred to as Specified Service Trades or Businesses (“SSTBs”) discussed more later, unless the taxpayer’s taxable income is below certain thresholds ($157,500 for single filers and $315,000 for married joint filers).
For certain taxpayers above those income thresholds whose business income does not flow from SSTBs, there are still certain wage and/or property basis limitations that can factor in and limit the allowable 20% deduction. Thus, the form and amount of compensation paid from certain businesses can impact 20% deduction ability, as can the decision whether to own certain assets inside a qualifying business activity. And certain aggregation rules can sometimes be used to group related businesses to help achieve desired effects.
Rules and limitations on the Sec 199A deduction are very complex and may require substantial planning and projections to optimize. More details on this important new deduction are discussed later.
Vehicle-Related Deductions and Substantiation of Deductions: Expenses relating to business vehicles can add up to major deductions. So, if your business might benefit from the purchase of a large passenger vehicle, consideration should be given to purchasing a sports utility vehicle or truck with Gross Vehicle Weight Rating (GVWR) more than 6,000 pounds. Vehicles under that weight limit are subject to much lower first-year and annual depreciation limits. However, for SUVs and certain small trucks and vans in excess of that GVWR, up to $25,000 of the cost of the vehicle can be immediately expensed, as was the case under prior law. Also, certain full-size trucks and vans with large cargo areas, this $25,000 cap does not apply.
Vehicle expense deductions are generally calculated using one of two methods: the standard mileage rate method or the actual expense method. If the standard mileage rate is used, parking fees and tolls incurred for business purposes can be added to the total amount calculated. Since the IRS tends to focus on vehicle expenses in an audit and disallow them if they are not properly substantiated, taxpayers should maintain the following tax records with respect to each vehicle used in the business: (1) the amount of each separate expense with respect to the vehicle (e.g., the cost of purchase or lease, the cost of repairs and maintenance, insurance, and fuel); (2) the amount of mileage for each business or investment use and the total miles for the tax period; (3) the date of the expenditure; and (4) the business purpose for the expenditure. The following are considered adequate for substantiating such expenses: (1) records such as a notebook, diary, log, statement of expense, or trip sheets; and (2) documentary evidence such as receipts, canceled checks, bills, or similar evidence. Records are considered adequate to substantiate the element of a vehicle expense only if they are prepared or maintained in such a manner that each recording of an element of the expense is made at or near the time the expense is incurred.
Retirement Plans and Other Fringe Benefits: Because benefits are very attractive to employees, you might consider using benefits rather than higher wages to attract employees. While a business is not required to have a retirement plan, there are many advantages to having one. For example, by starting a retirement savings plan, an employer not only helps employees save for the future, the employer can also use such a plan to attract and retain qualified employees. Retaining employees longer can impact a business’s bottom line by reducing training costs. In addition, a business owner (and spouse in some cases if on payroll) can take advantage of the plan also.
By offering a retirement plan, a business owner can generate tax savings for the business, since employer contributions are tax deductible and the assets in the retirement plan grow tax free. Additionally, a tax credit is available to certain small employers for the costs of starting a retirement plan.
Also, as noted above, for 2018 and 2019, eligible employers can claim a general business credit equal to 12.5 percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave under an employer’s plan if the rate of payment under the program is 50 percent of the wages normally paid to an employee.
Increasing Basis in Pass-thru Entities: If your S corporation or partnership is going to pass through a loss, it’s advisable to double check with your CPA that you have enough basis in the loss-generating entity to deduct the loss. If not, then you may consider increasing your basis in that entity in order to deduct the loss for 2018 taxes if doing so is financially appropriate.
De Minimis Safe Harbor Election: If you have not already done so, it may be advantageous to elect the annual de minimis safe harbor election in Reg. Sec. 1.263(a)-1(f)(1)(ii)(D) for amounts paid to acquire or produce tangible property. By making this election, and as long as the items purchased don’t have to be capitalized under the uniform capitalization rules and are expensed for financial accounting purposes or in your books and records, you can deduct up to $2,500 per invoice or item (or up to $5,000 if you have an applicable financial statement).
This election, combined with new higher income limits for cash basis accounting, presents opportunities for some businesses to accelerate deductions for inventory items also by electing to expense them as acquired under the $2500 limit above. Inventory items above this amount would be considered nonincidental materials and supplies and subject to capitalization, however. Special rules and limitations apply though.
Accounting Method Changes: If you think that your business might benefit from a change in tax accounting method, then the appropriate tax forms will have to be filed to initiate the changes in addition to setting up your books and records to reflect the new method of accounting. Under the new law businesses with up to $25 million in gross receipts can generally qualify to use the cash method of accounting for tax purposes. And businesses with long-term contracts may be eligible to use the completed-contract method to defer net income if they meet this same $25 million gross receipts test. More on these changes later.
S Corporation Shareholder Salaries: For any business operating as an S corporation, it’s important to ensure that shareholders involved in running the business are paid an amount that is commensurate with their workload and experience. The IRS often scrutinizes S corporations that distribute profits instead of paying compensation subject to employment taxes. Failing to pay arm’s length salaries can lead not only to tax deficiencies, but penalties and interest on those deficiencies as well. The key to establishing reasonable compensation is being able to show that the compensation paid for the type of work an owner-employee does for the S corporation is similar to what other corporations would pay for similar work. If you are in this situation, the tax return workpapers should include documentation of the factors that support the salary that you as the owner are being paid.
Centralized Partnership Audit Regime: The new centralized partnership audit regime took effect in 2018. The rules potentially change who is responsible for representing the partnership in audit proceedings and how tax adjustments are assessed to partners. As a result, most partnerships (including LLC’s taxed as partnerships) may need to update their partnership or operating agreements to reflect the new regime.
In Case You Missed It
Here are some of the changes that are impacting 2018 Business Taxes, in case you missed them.
Section 179 Deduction: For 2018, businesses can write off up to $1,000,000 of qualifying property under Code Sec. 179. This change is aimed at boosting a businesses’ tax deductions so that the money saved on taxes can be plowed back into the business. Additionally, writing off an asset in the year it is purchased may reduce recordkeeping requirements. The $1,000,000 amount is reduced (but not below zero) by the amount by which the cost of the qualifying property placed in service during the tax year exceeds $2,500,000.
In addition, the definition of property that qualifies for the Code Sec. 179 deduction was expanded to include certain depreciable tangible personal property used predominantly to furnish lodging, or in connection with furnishing lodging, as well as any of the following improvements to nonresidential real property: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.
Bonus Depreciation Deduction: The new tax law extended and modified the additional first-year (i.e., “bonus”) depreciation deduction, which had been scheduled to end in 2019. An enhanced bonus depreciation deduction is now available through 2026. Under the new rules, the 50-percent additional depreciation allowance that was previously allowed has been increased to 100 percent for property placed in service after September 27, 2017, and before January 1, 2023, as well as for specified plants planted or grafted after September 27, 2017, and before January 1, 2023. These deadlines are extended for certain longer production period property and certain aircraft.
The 100-percent allowance is phased down by 20 percent per calendar year in tax years beginning after 2022 (after 2023 for longer production period property and certain aircraft).
Another new provision removes the requirement that, in order to qualify for bonus depreciation, the original use of qualified property must begin with the taxpayer. Thus, the bonus depreciation deduction applies to purchases of used as well as new items.
TCJA also expands the definition of qualified property eligible for bonus depreciation to include qualified film, television and live theatrical productions, effective for productions placed in service before January 1, 2027.
Additional Depreciation on “Luxury” Automobiles and Certain Personal Use Property: Another benefit of the new tax law is that it increases the depreciation limitations that apply to certain “listed” property such as vehicles with a GVWR of 6,000 lbs or less (known as “luxury” automobiles). For luxury automobiles acquired after September 27, 2017, and placed in service after 2017, an additional $8,000 deduction is available, thus making the write-off for the first year $18,000. The deduction is $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years in the recovery period. In addition, computer or peripheral equipment is no longer considered listed property, which means that such property is not subject to the heightened substantiation requirements that previously applied.
New Section 199A 20% Deduction for Qualified Business Income: One of the biggest changes for 2018 is the new qualified business income (QBI) deduction, discussed some above. A sole proprietor, a partner in a partnership, a member in an LLC either disregarded for tax purposes or taxed as a partnership or S corporation, or a shareholder in an S corporation, may be entitled to a deduction up to 20% of QBI for tax years beginning after December 31, 2017, and before January 1, 2026. Trusts and estates are also eligible for this deduction.
While there are important restrictions to taking this deduction, the amount of the deduction is generally 20% of qualifying business income from a qualified trade or business. A qualified trade or business means any trade or business other than –
- a specified service trade or business (“SSTB”); or
- the trade or business of being an employee.
A “specified service trade or business” is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business.
However, there is a special rule which allows a taxpayer to take this deduction even if the taxpayer has a specified service trade or business. Under that rule, the provision disqualifying such businesses from being considered a qualified trade or business for purposes of the QBI deduction does not apply to individuals with taxable income of less than $157,500 ($315,000 for joint filers). After an individual reaches the threshold amount, the restriction is phased in over a range of $50,000 in taxable income ($100,000 for joint filers). Thus, clients with income that falls within this range are entitled to a partial deduction. Once the end of the range is reached, the deduction is completely disallowed.
For purposes of the deduction, items are treated as qualified items of income, gain, deduction, and loss only to the extent they are effectively connected with the conduct of a trade or business within the United States. In calculating the deduction, QBI refers to the net amount of qualified items of income, gain, deduction, and loss with respect to the qualified trade or business of the taxpayer.
QBI does not include any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer, or any guaranteed payment (or other payment) to a partner in a partnership for services rendered with respect to the trade or business. Qualified items do not include specified investment-related income, deductions, or losses, such as capital gains and losses, dividends and dividend equivalents, interest income other than that which is properly allocable to a trade or business, and similar items.
If the net amount of QBI from all qualified trades or businesses during the tax year is a loss, it is carried forward as a loss from a qualified trade or business to the next tax year (and reduces the QBI for that year).
W-2 Wage Limitation. The deductible amount for each qualified trade or business is the lesser of:
- 20 percent of the taxpayer’s QBI with respect to the trade or business; or
- the greater of: (a) 50 percent of the W-2 wages with respect to the trade or business, or (b) the sum of 25 percent of the W-2 wages with respect to the trade or business and 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property (generally all depreciable property still within its depreciable period at the end of the tax year).
The W-2 wage limitation does not apply to individuals with taxable income of less than $157,500 ($315,000 for joint filers). After an individual reaches the threshold amount, the W-2 limitation is phased in over a range of $50,000 in taxable income ($100,000 for joint filers).
In the case of an entity taxed as a partnership or S corporation, the business income deduction applies at the partner or shareholder level. Each partner in a partnership takes into account the partner’s allocable share of each qualified item of income, gain, deduction, and loss, and is treated as having W-2 wages for the tax year equal to the partner’s allocable share of W-2 wages of the partnership. Similarly, each shareholder in an S corporation takes into account the shareholder’s pro rata share of each qualified item and W-2 wages.
The deduction for QBI is subject to some overriding limitations relating to taxable income, net capital gains, and other items and will not affect the amount of the deduction in most situations.
Changes in Accounting Method Rules: The new tax law has also expanded the number of businesses eligible to use the cash method of accounting as long as the business satisfies a gross receipts test. This test allows businesses with annual average gross receipts that do not exceed $25 million for the three prior tax-year period to use the cash method. A similar gross receipts threshold provides an exemption from the following accounting requirements/methods:
- (1) uniform capitalization rules;
- the requirement to keep inventories; and
- the requirement to use the percentage-of-completion method for certain long-term contracts (thus allowing the use of the more favorable completed-contract method, or any other permissible exempt contract method).
Carryover of Business Losses Is Now Limited: Beginning in 2018, excess business losses of a taxpayer other than a corporation are not allowed for the tax year. Under this excess business loss limitation, a taxpayer’s loss from a non-passive trade or business is limited to $500,000 (married filing jointly) or $250,000 (all other taxpayers). Thus, such losses cannot be used to offset other income currently. Instead, if a business incurs such excess losses, those losses are carried forward and treated as part of the business’s net operating loss carryforward in subsequent tax years.
New Interest Deduction Limitations. Effective for 2018, the deduction for business interest is limited to the sum of business interest income plus 30 percent of adjusted taxable income for the tax year. However, there is an exception to this limitation for certain small businesses discussed below, certain real estate businesses that make an election to be exempt from this rule, businesses with floor plan financing (i.e., a specialized type of financing used by car dealerships), and for certain regulated utilities.
The new law exempts from the interest expense limitation taxpayers with average annual gross receipts for the three-taxable year period ending with the prior tax year that do not exceed $25 million. Further, at the taxpayer’s election, any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business is not treated as a trade or business for purposes of the limitation, and therefore the limitation does not apply to such trades or businesses.
Business Net Operating Losses: Under the new law, business net operating losses may only be carried forward, not back, and are limited to 80% of taxable income in the carryforward year.
Elimination of Entertainment Deduction: The new tax law also eliminated business deductions for entertainment. As a result, no deduction is allowed with respect to:
- an activity generally considered to be entertainment, amusement or recreation;
- membership dues with respect to any club organized for business, pleasure, recreation or other social purposes; or
- a facility or portion thereof used in connection with any of the above items.
Under prior law, there was an exception to this rule for entertainment, amusement, or recreation directly related to (or, in certain cases, associated with) the active conduct of a trade or business. This is no longer the case.
In addition, a business can no longer deduct expenses associated with providing any qualified transportation fringe benefits to employees, except as necessary for ensuring the safety of an employee, including any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of employment.
A business may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees during work travel, or business meals with customers, clients, or prospects). If meals are combined with entertainment, the meal portion needs to be separately stated in order for the business to deduct the meal expense.
Employer Credit for Paid Family and Medical Leave: For 2018 and 2019, eligible employers can claim a general business credit equal to 12.5 percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave if the rate of payment under the program is 50 percent of the wages normally paid to an employee. The credit is increased by 0.25 percentage points (but not above 25 percent) for each percentage point by which the rate of payment exceeds 50 percent.
Given the cost of implementing such a policy and complying with reporting requirements, the credit may be impractical for many employers to pursue during the short period it’s available. For businesses that already have a qualifying family and medical leave plan in place, however, the credit may provide a nice windfall.
Changes to Partnership Rules: Several changes were made to the partnership tax rules. First, gain or loss from the sale or exchange of a partnership interest is treated as effectively connected with a U.S. trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at fair market value as of the date of the sale or exchange. Any gain or loss from the hypothetical asset sale by the partnership is allocated to interests in the partnership in the same manner as non-separately stated income and loss.
Second, the transferee of a partnership interest must withhold 10 percent of the amount realized on the sale or exchange of the partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation.
Third, the definition of a substantial built-in loss has been modified so that a substantial built-in loss is considered to exist if the transferee of a partnership interest would be allocated a net loss in excess of $250,000 upon a hypothetical disposition by the partnership of all of the partnership’s assets in a fully taxable transaction for cash equal to the assets’ fair market value, immediately after the transfer of the partnership interest. This could necessitate the adjustment of the basis of partnership property.
Fourth, TCJA modifies the basis rules on partner losses to provide that for partnership tax years beginning after Dec. 31, 2017, in determining the amount of a partner’s loss, the partner’s distributive shares under Code Sec. 702(a) of partnership charitable contributions and taxes paid or accrued to foreign countries or U.S. possessions are taken into account. However, in the case of a charitable contribution of property with a fair market value that exceeds its adjusted basis, the partner’s distributive share of the excess is not taken into account.
Lastly, the rule providing for technical terminations of partnerships has been repealed.
Changes to S Corporation Rules: Several changes were also made to the tax rules involving S corporations. First, income that must be taken into account when an S corporation revokes its S corporation election is taken into account ratably over six years, rather than the four years under prior law. Second, a nonresident alien individual can be a potential current beneficiary of an electing small business trust (ESBT). Third, the charitable contribution deduction of an ESBT is not determined by the rules generally applicable to trusts anymore but rather by the rules applicable to individuals starting in 2018. Thus, the percentage limitations and carryforward provisions applicable to individuals apply to charitable contributions made by the portion of an ESBT holding S corporation stock.
If you would like to discuss how these changes affect your particular situation and any planning moves you should consider in light of them, please contact one of our experienced tax professionals.
This document and the attachments linked herein are intended only as a general summary of certain elements of proposed tax legislation. Please consult your tax advisor for assistance with your specific tax situation, as taxpayer-specific factors can substantially impact these provisions