The December 2017 passage of the largest overhaul of the federal income tax system since 1986 promises to bring many U.S. businesses some dramatic savings. At nearly 500 pages, the Tax Cuts and Jobs Act (TCJA) includes a wide range of significant business-related changes for both corporations and smaller businesses.
Slashed tax rates
Much has been made of the savings for corporations. Perhaps most important, C corporations will see their tax rate cut, with certain exceptions, from 35% to 21% in 2018. They’ll also benefit from the repeal of the corporate alternative minimum tax and other changes.
The TCJA doesn’t overlook businesses that operate as partnerships, limited liability companies, S corporations and sole proprietorships, though. The owners and shareholders of such “pass-through” entities had paid taxes on their net income at individual ordinary income tax rates, which had reached as high as 39.6%. The TCJA reduces individual tax rates, though, with the highest rate falling to 37%. It also raises thresholds, so the top rate doesn’t kick in until taxable income hits $500,000 for single filers — and $600,000 for joint filers.
But that’s not all. The TCJA creates a valuable new deduction that will shrink taxable income from pass-through entities. The “qualified business income” deduction generally allows owners and shareholders to deduct 20% of qualified income (exclusive of reasonable compensation) from a pass-through.
The deduction comes with some “guardrails” to prevent abuse. When taxable income exceeds $157,500 for single filers or $315,000 for joint filers, a “wage limit” begins phasing in. Taxpayers generally can deduct the lesser of:
- 20% of qualified business income, or
- The greater of 1) 50% of the W-2 wages paid by the business or 2) 25% of the wages paid plus 2.5% of the unadjusted basis (purchase price) of tangible depreciable property (for example, equipment), subject, of course, to certain restrictions.
The wage limit phases out completely at $207,500 for single filers and $415,000 for joint filers.
The business income deduction is further limited for “specified trades or businesses” (for example, law or accounting firms, consultants, or any business where the principal asset is the reputation or skill of one or more of its employees). It begins to phase out at $157,500 in taxable income for single filers and $315,000 for joint filers, phasing out completely at $207,500 and $415,000, respectively.
The TCJA extends bonus depreciation for qualifying property (for example, office furniture, software and qualified improvement property), allowing businesses to deduct 100% of the cost of such property (both new and old) the year the property is placed in service (with an additional year for certain property with a longer production period). Bonus depreciation will begin to phase out in 2023, with the amount of the allowable deduction dropping 20% each year until reaching zero in 2027.
The law expands the immediate expensing under Section 179, too, doubling the maximum deduction for qualifying property to $1 million (adjusted for inflation), with a phaseout threshold of $2.5 million (up from $2 million).
Smaller interest expense deductions
Businesses accustomed to deducting 100% of their interest expense will be unhappy to learn of the new limit on these deductions. The TCJA generally restricts the deduction to 30% of adjusted taxable income.
The law does allow an indefinite carryforward for unused interest expense, though (with special rules for partnerships). And some companies, such as those whose average annual gross receipts don’t exceed $25 million, and real estate businesses, are exempt.
The bottom line
The TCJA includes numerous additional provisions that could affect your business’s taxes, including changes related to net operating losses, a repeal of the domestic production activities deduction, limits on excessive compensation and the disallowance of deductions for entertainment expenses. We can help you take advantage of the favorable provisions — and determine how best to use the savings.