Tax Insights: Top 12 Tax Cuts and Jobs Act Changes Affecting Businesses and Their Owners
H.R. 1, known as the Tax Cuts and Jobs Act, became law on December 22, 2017. This resulted in the most significant overhaul of the Internal Revenue Code in more than 30 years. The following are some highlights of the Act affecting the federal income taxes of many businesses and their owners:
Corporate Tax Rate Lowered and AMT Eliminated. For tax years beginning after 2017, the corporate tax rate is reduced from a top rate of 35% to a flat rate of 21%, and the corporate alternative minimum tax was repealed.
Lower Individual Tax Rates. For tax years beginning after 2017 and before 2026, seven tax rates apply for individuals: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The top bracket applies to taxable income over $600,000 if married filing jointly ($500,000 if single). Previously, the top rate was 39.6%, which kicked in for taxable income over $470,700 if married filing jointly ($418,400 if filing single). Personal exemptions were eliminated but the standard deduction and child tax credits were significantly increased. Lower limits were placed on the home mortgage interest deduction, and an annual limit of $10,000 was placed on state and local tax deductions.
New 20% Qualified Business Income Deduction for Non-Corporate Taxpayers. New Section 199A provides that an individual, trust or estate that has qualified business income (“QBI”) could be entitled to a deduction of up to 20% of the amount of such income for tax years beginning after 2017 and before 2026. QBI includes income earned through partnerships, S corporations, sole proprietorships and LLCs (except those electing to be taxed as C corporations). For taxpayers with taxable income above certain thresholds, the deduction cannot exceed the greater of (i) 50% of the taxpayer’s share of the business’s W-2 wages paid or (ii) the sum of 25% of such share of the W-2 wages paid plus 2.5% of the taxpayer’s share of the business’s unadjusted basis, tangible, depreciable business property. Additional limitations apply for certain specified service businesses, such as businesses involved in the fields of health, law, accounting, consulting and finance. Taxpayers having taxable income below certain thresholds can qualify for the 20% deduction even if their income is earned through one of the specified service businesses.
Domestic Production Activities Deduction Eliminated. After 2017, the domestic production activities deduction under Section 199 is repealed.
100% Depreciation Deduction. A 100% depreciation deduction is allowed for qualified property placed in service after September 27, 2017 and before 2023 (2024 for certain property with longer production periods). This deduction is allowed for both new and used property. The deduction amount phases down 20% each year beginning after 2022.
Increased Section 179 Expensing. After 2017, the amount that may be expensed under Section 179 is $1 million for qualified property. The phase-out threshold amount is $2.5 million indexed for inflation.
Business Interest Deduction Limited But May Carry Forward. After 2017, all businesses are generally disallowed a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income, which, after 2017 and before 2022, is computed without regard to deductions allowed for depreciation, amortization, or depletion. Any business interest not deductible is treated as business interest paid or accrued in the subsequent taxable year. The interest may generally be carried forward indefinitely, and the net interest expense disallowance is generally determined at the tax filer level.
Net Operating Loss Deduction Limited and Carryback Generally Repealed. For net operating losses (NOLs) arising after 2017, the NOL deduction is limited to 80% of taxable income, which is determined without regard to the deduction. NOLs can generally be carried forward indefinitely, but the two-year carryback and special carryback provisions are generally repealed, except for farming.
Like-Kind Exchanges Limited to Real Property. After 2017, tax-free like-kind exchanges are allowed only with respect to real property held for use in a trade or business or for investment.
Change to Deduction Limit for Excessive Employee Remuneration. For tax years beginning after 2017, there will no longer be commission and performance-based compensation exceptions to the $1 million annual limit on the deduction for executive compensation paid by publicly-traded corporations to certain covered officers. These now include the corporation’s current and former CEOs, CFOs, and three other highest paid officers each year (whether current or former). An exception is available for any remuneration under a written binding contract that was in effect on or before November 2, 2017 and not materially modified afterwards.
Fringe Benefit Expenses. After 2017, deductions for entertainment expenses, employee transportation fringe benefits, and transportation expenses that are the equivalent of commuting for employees (except as provided for the employee’s safety) are disallowed. However, if provided by an employer, an employee can still exclude qualified transportation fringe benefits from the employee’s income. The current limit on business meal deductions is expanded to meals provided on the employer’s premises.
Transition from a “Worldwide” to a “Territorial” International Tax System. In general, after 2017, only corporate income earned in the US will be subject to US tax and dividends from foreign subsidiaries will be exempt from tax, which, along with a one-time mandatory deemed repatriation of undistributed earnings of foreign subsidiaries and other anti-abuse provisions, will attempt to move the US from a worldwide to a territorial international tax system.
The Act includes many more provisions than those highlighted here. Many of these are industry or taxpayer specific.