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Tax reform and its impact on business
H.R. 1, also known as the Tax Cuts and Jobs Act, was signed into law Dec. 22, 2017. The new tax act implemented some of the most significant changes since the Tax Reform Act of 1986. Below is a summary of some of those changes.
Corporate tax rate: The tax rate for C Corporations was changed from a progressive-rate system with a maximum rate of 35 percent to a flat rate of 21 percent. The rates for qualified dividends and the investment income tax remain unchanged.
Deduction for pass-through entities: Noncorporate owners of pass-through entities, such as S Corporations and partnerships (including most LLCs), will now be entitled to an additional deduction from their taxable income. For taxpayers below the threshold amount ($157,500 for single filers and $315,000 for joint filers), the deduction is generally equal to 20 percent of the qualified business income that is allocated to the taxpayer. For taxpayers whose taxable income is above the threshold amount, the calculation is much more complicated but may still yield a significant deduction. This calculation takes into account the business’ W-2 wages and original unadjusted basis of its assets. For taxpayers who have an ownership in a specified service profession, such as health care, law, accounting, etc. (engineers and architects are specifically excluded), the deductions get phased out beginning with taxable income over the threshold amount.
Entertainment and meal expenses: All expenses incurred in connection with an activity generally considered to be entertainment, amusement or recreation, including facilities used for those activities, are no longer deductible. This includes food, beverages and other costs associated with entertainment activities. Membership dues for clubs organized for business, pleasure, recreation or other social purposes also are disallowed. With some exceptions, the act generally retained the deduction for meals associated with nonentertainment activities and limits those deductions to 50 percent of the cost.
Qualified transportation fringe benefits: Expenses incurred for qualified transportation fringe benefits are no longer deductible. This includes costs for employee commuting, transit passes, employee parking and qualified bicycle commuting reimbursement.
Net operating loss carry-forward: Net operating losses still may be carried forward, but they may only be used to offset up to 80 percent of taxable income determined before the NOL deduction.
Interest deduction: The deduction for business interest expense is limited to the sum of 30 percent of the taxpayer’s adjusted taxable income plus the taxpayer’s floor plan financing costs for the year. Unused deductions may be carried forward. The limitation does not apply to businesses with gross receipts of $25 million or less.
Credit for paid family leave: Eligible employers are entitled to a credit equal to 12.5 percent of wages paid to qualified employees while the employee is on leave under the Family Medical Leave Act. To qualify, the employer must pay the employee at least 50 percent of his or her normal wages. The credit increases by 0.25 percent for each percentage point by which the payment exceeds 50 percent. The total credit may not exceed 25 percent and the maximum amount of leave that may be considered may not exceed 12 weeks. An employer can only claim the credit for employees who have been employed by the employer for at least one year and who earn less than $72,000. This credit applies to amount paid in 2018 and 2019 only.
Corporate AMT: The alternative minimum tax for corporations has been repealed.
Depreciation: The maximum section 179 deduction was increased to $1 million and increased the threshold amount for phasing out the deduction to $2.5 million. Bonus depreciation also was enhanced. For qualified property acquired and placed in services after Sept. 27, 2017, and before Jan. 1, 2023, 100 percent bonus depreciation is permitted. The bonus depreciation percentage is reduced each year for qualified property placed in service after Dec. 31, 2022. Qualified property includes tangible personal property with a recovery period of 20 years or less and includes qualified film, television and live theatrical productions.
Local lobbying expenses: The act eliminated the deduction for lobbying expenses regarding legislation before local government bodies and Indian tribes. The existing disallowance of deductions for lobbying expense remained intact.
Accounting method: Taxpayers with average annual gross receipts of less than $25 million for the three prior taxable years may use the cash method of accounting, regardless of the entity structure. The inventory accounting rules for these businesses also was simplified.
The act contains many other provisions that affect businesses and business owners. Some of the changes are industry-specific, affecting businesses engaged in agriculture, craft brewing and life insurance. Early and effective planning will be necessary to maximize the benefits and minimize the limitations brought about by the act.
Peter Lozicki is a tax and business attorney at Rhoades McKee in Grand Rapids.