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Tax Cuts and Jobs Act -- Business Provisions

Date: 1/8/2018

Business provisions

Corporate rate. The Act provides for a flat 21 percent corporate rate, rather than the originally proposed 20 percent rate. There is no separate rate for personal service corporations. The 21 percent rate becomes effective for tax years beginning after Dec. 31, 2017.

Corporate AMT. The corporate AMT is repealed. Prior-year minimum tax credits may offset a taxpayer’s regular tax liability for tax years beginning after 2017, subject to a formula.

 

Business income deduction for pass-through business entities. The Act provides for a 20 percent deduction for domestic qualified business income from a partnership, S corporation or sole proprietorship. The deduction does not apply to specified service businesses, except in the case of a taxpayer whose taxable income is below the threshold amount. Under the conference agreement, the threshold amount is $157,500 (twice that amount or $315,000 in the case of a joint return). The conferees expect the reduced threshold amount will serve to deter high-income taxpayers from attempting to convert wages or other compensation for personal services to income eligible for the 20 percent deduction under the provision. The conference agreement provides that the range over which the phase-in of these limitations applies is $50,000 ($100,000 in the case of a joint return).

A specified service trade or business means any trade or business involving the performance of services in the fields of health, law, consulting, athletics, financial services, brokerage services, or 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 or owners, or which involves the performance of services that consist of investing and investment management trading, or dealing in securities, partnership interests or commodities.

The final version of the legislation modifies the wage limit applicable to taxpayers with taxable income above the threshold amount to provide a limit based either on wages paid or on wages paid plus a capital element. Under the conference agreement, the limitation is the greater of:

1.       50 percent of the W-2 wages paid with respect to the qualified trade or business, or

2.       The sum of 25 percent of the W-2 wages with respect to the qualified trade or business plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property.

For example, a taxpayer (who is subject to the limit) does business as a sole proprietorship conducting a widget-making business. The business buys a widget-making machine for $100,000 and places it in service in 2020. The business has no employees in 2020. The limitation in 2020 is the greater of (a) 50 percent of W-2 wages, or $0, or (b) the sum of 25 percent of W-2 wages ($0) plus 2.5 percent of the unadjusted basis of the machine immediately after its acquisition: $100,000 x .025 = $2,500. The amount of the limitation on the taxpayer’s deduction is $2,500.

The Treasury Department is expected to issue guidance in regard to the acquisition of property from related parties as well as other guidance around the capital component rule.

The conference agreement clarifies that the 20 percent deduction is not allowed in computing adjusted gross income and instead is allowed as a deduction reducing taxable income. For example, the provision does not affect limitations based on adjusted gross income. Similarly, the conference agreement clarifies that the deduction is available to both non-itemizers and itemizers.

The conference agreement provides that trusts and estates are eligible for the 20 percent deduction under the provision. Rules similar to those under present-law section 199 apply for apportioning between fiduciaries and beneficiaries any W-2 wages and unadjusted basis of qualified property under the limitation based on W-2 wages and capital.

Qualified REIT dividends, cooperative dividends and publicly traded partnership income are all eligible for this deduction. However, qualified REIT dividends do not include any portion of a dividend received from a REIT that is a capital gain dividend or a qualified dividend.

Full expensing of certain assets. Businesses would be able to fully expense qualified property (tangible personal property with a recovery period of 20 years or less) acquired after Sept. 27, 2017, and before Jan. 1, 2023. This provision is applicable for the acquisition of new and used property. The inclusion of used property is a significant change from previous bonus depreciation rules.

Under the conference agreement, the bonus depreciation rates are as follows.

Placed-in-service year

Bonus depreciation percentage

Qualified property in general/specified plants

Longer production period property and certain aircraft

Portion of basis of qualified property acquired before Sept. 28, 2017, but placed in service after Sept. 27, 2017

Sept. 28, 2017 − Dec. 31, 2017

50 percent

50 percent

2018

40 percent

50 percent

2019

30 percent

40 percent

2020

None

30 percent

2021 and thereafter

None

None

Portion of basis of qualified property acquired and placed in service after Sept. 27, 2017

Sept. 28, 2017 − Dec. 31, 2022

100 percent

100 percent

2023

80 percent

100 percent

2024

60 percent

80 percent

2025

40 percent

60 percent

2026

20 percent

40 percent

2027

None

20 percent

2028 and thereafter

None

None

A transition rule provides that, for a taxpayer’s first taxable year ending after Sept. 27, 2017, the taxpayer may elect to apply a 50 percent allowance instead of the 100 percent allowance.

For passenger automobiles placed in service after Dec. 31, 2017, and for which the additional first-year depreciation deduction under section 168(k) is not claimed, the maximum amount of allowable depreciation is $10,000 for the year in which the vehicle is placed in service, $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. The limitations are indexed for inflation for passenger automobiles placed in service after 2018. The provision removes computer or peripheral equipment from the definition of listed property. Such property is therefore not subject to the heightened substantiation requirements that apply to listed property.

Section 179 expensing. The Act increases the maximum amount a taxpayer may expense under section 179 to $1 million and increases the phase-out threshold amount to $2.5 million. The $1 million limitation is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $2.5 million. The $1 million and $2.5 million amounts, as well as the $25,000 sport utility vehicle limitation, are indexed for inflation for taxable years beginning after 2018.

The Act also expands the definition of qualified real property eligible for section 179 expensing to include any of the following improvements to nonresidential real property placed in service after the date such property was first placed in service: roofs; heating, ventilation and air-conditioning property; fire protection and alarm systems; and security systems.

 

NOL limitations. Net operating loss (NOL) rules have been modified so taxpayers can now only deduct NOLs up to 80 percent of taxable income, and most taxpayers can no longer carry an NOL back two years. Instead of a 20-year carryforward limitation, taxpayers can carry suspended NOLs forward indefinitely.

Effective date. The provision allowing indefinite carryovers and modifying carrybacks applies to losses arising in taxable years beginning after Dec. 31, 2017. The provision limiting the NOL deduction applies to losses arising in taxable years beginning after Dec. 31, 2017.

 

Business losses of noncorporate taxpayers. The Act creates a new restriction for noncorporate taxpayers with “excess business losses.” For this purpose, excess business losses are the amount by which business deductions exceed gross business income. This provision would limit such losses to $500,000 for married filing jointly ($250,000 for others) per year with both amounts indexed for inflation. In other words, business losses cannot offset nonbusiness income by more than the allowed amounts in any taxable year. Any excess loss would be carried forward as a net operating loss carryforward in subsequent tax years. This is a significant restriction over current law.

 

Accounting methods. The Act provides several provisions reforming and simplifying accounting methods for small businesses.

·         Cash method of accounting. Under current law, a corporation or partnership with a corporate partner may only use the cash method of accounting if its average gross receipts do not exceed $5 million for all prior years (including the prior tax years of any predecessor of the entity). The Act increases to $25 million the $5 million threshold for corporations and partnerships with a corporate partner and repeals the requirement that such businesses satisfy the requirement for all prior years.
Presently, farm corporations and farm partnerships with a corporate partner may only use the cash method of accounting if their gross receipts do not exceed $1 million in any year. An exception allows certain family farm corporations to qualify if its gross receipts do not exceed $25 million. The Act extends the increased $25 million threshold (above) to farm corporations and farm partnerships with a corporate partner as well as family farm corporations (the average gross receipts test would be indexed for inflation).

·         Accounting for inventories. The Act permits businesses with average gross receipts of $25 million or less to use the cash method of accounting even if the business has inventory. In contrast, the cash method currently can only be used for certain small businesses with average gross receipts of not more than $1 million (for businesses in certain industries that have annual gross receipts that do not exceed $10 million). Under the cash method, the business could account for inventory as non-incidental materials and supplies. The Act allows a business with inventories qualifying for and using the cash method to account for such inventories using the method of accounting reflected on its financial statements or its books and records.

·         Capitalization and inclusion of certain expenses in inventory costs. The Act fully exempts businesses with average gross receipts of $25 million or less from the uniform capitalization (UNICAP) rules. The UNICAP rules generally require certain direct and indirect costs associated with real or tangible personal property manufactured by a business to be included in either inventory or capitalized into the basis of such property. The Act’s exemption would apply to real and personal property acquired or manufactured by such business.

·         Accounting for long-term contracts. Under current law, an exception from the requirement to use the percentage-of-completion method (PCM) is provided for certain businesses with average annual gross receipts of $10 million or less in the preceding three years. The Act increases the $10 million average gross receipts exception to the PCM to $25 million, effective for tax years beginning after 2017. Businesses that meet the increased average gross receipts test would be allowed to use the completed-contract method (CCM) or any other permissible exempt contract method.

 

Depreciation lives. The Act eliminates the separate definitions of qualified leasehold improvement, qualified restaurant and qualified retail improvement property, and provides a general 15-year recovery period for qualified improvement property with a 20-year ADS recovery period. For example, qualified improvement property placed in service after Dec. 31, 2017, is generally depreciable over 15 years using the straight-line method and half-year convention without regard to (1) whether the improvements are to property subject to a lease; (2) placed in service more than three years after the date the building was first placed in service; or (3) made to a restaurant building. Restaurant building property placed in service after Dec. 31, 2017, that does not meet the definition of qualified improvement property, is depreciable over 39 years as nonresidential real property, using the straight-line method and the midmonth convention.

The Act retains depreciable lives of 39 and 27.5 years for nonresidential and residential rental property, respectively. However, it reduces the alternative depreciation life for residential rental property to 30 years from 40 years for those taxpayers subject to ADS.

Business credits retained. The Act retains the following credits that earlier versions proposed to eliminate:

·         New Markets Tax Credit (NMTC)

·         Employer-provided child care credit

·         Work Opportunity Tax Credit

Like-kind exchanges are generally repealed after 2017; however, exchanges of real property can still qualify.

Amortization of research and experimental procedures. Amounts defined as specified research or experimental expenditures are required to be capitalized and amortized ratably over a five-year period, beginning with the midpoint of the taxable year in which the specified research or experimental expenditures were paid or incurred. Specified research or experimental expenditures attributable to research conducted outside of the United States are required to be capitalized and amortized ratably over a period of 15 years, beginning with the midpoint of the taxable year in which such expenditures were paid or incurred. Specified research or experimental expenditures subject to capitalization include expenditures for software development. The new law applies to amounts paid or incurred in tax years beginning after Dec. 31, 2021.

DPAD. The section 199 domestic production activities deduction is repealed.

For more information contact the tax experts at Heemer Klein via the contact page of this website or 586-751-6060.