President Donald Trump signed The Tax Cuts and Jobs Act (TCJA) bill on December 22, 2017. This bill contains sweeping tax changes which primarily take effect beginning with the 2018 tax year.
These changes affect individual taxpayers as well as businesses. The changes in the new tax law for businesses are generally permanent. This is in contrast to the new tax law impacting individual taxpayers, where most of the new provisions expire after tax year 2025 if Congress does not extend them at some point.
Keep in mind, however, that business tax law changes do impact individual taxpayers as well. Individuals are owners, employees, and customers of such businesses, and will therefore be affected.
Below is an overview of some of the key changes regarding business taxes.
Corporate Tax Rates
The applicable tax rates for corporations have been changed in the new tax law for tax years beginning after December 31, 2017. There is a new flat rate of 21%. Previously, there was a graduated rate structure with rates of 15%, 25%, 34%, and a top rate of 35%.
This new rate also applies to personal service corporations, which previously were taxed using a flat 35% tax rate.
Alternative Minimum Tax
The alternative minimum tax (AMT) for corporations has been repealed. However, prior-year minimum tax credits may still offset regular tax liability for years beginning after 2017.
Dividends Received Deduction
The new tax law also reduces the 70% and 80% dividends received deductions for corporate entities to 50% and 65%, respectively.
The (first-year) bonus depreciation is increased under the new tax law from 50% to 100%. This change applies to property placed in service after September 27, 2017 but before January 1, 2023. The new percentage will then be gradually phased out over the next five years. It will be 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026, and zero thereafter.
The new law also allows bonus depreciation to be claimed on used as well as new property.
Section 179 Expense
The Sec 179 limit for expensing qualifying business property has been increased to $1 million. If more than $2.5 million in qualifying property is placed in service, then there is a dollar-for-dollar phaseout of the deduction limit above this amount. Under the old tax law, these figures were $500K for the deduction limit and $2 million for the phaseout threshold.
The new law also expanded the definition of qualifying business property. Certain tangible personal property used to furnish lodging now qualifies, as do certain improvements to nonresidential property. Examples include roofs, HVAC, and alarm systems.
Don’t forget that you can only deduct Sec 179 expense to the extent that you have net income from the business activity.
The annual maximum depreciation limits for luxury (passenger) cars used for business have been increased under the new law.
The IRS defines a luxury (passenger) car as any four-wheeled vehicle (not including trucks and vans) manufactured primarily for use on public roads, and which is rated at a a gross vehicle weight (GVW) of 6,000 pounds or less.
These new limits are effective for vehicles placed in service after December 31, 2017 and during taxable years ending after such date.
Note that these limitations are indexed for inflation, and apply to passenger autos placed in service after 2017 and used at least 50% for business purposes.
Domestic Production Activities Deduction
This deduction was primarily available under the old law to encourage businesses to manufacture their products in the United States. As part of the new tax law and corporate rate structure changes, this deduction has been repealed.
Like Kind Exchanges
The Section 1031 rules for deferring tax on a like-kind exchange are only available for real property after 2017. Exchanges of personal property such as vehicles will no longer qualify for like-kind tax deferred treatment.
Deduction for Entertainment Expenses
Entertainment expenses related to the conduct of business activities are no longer deductible. Under the old law 50% of such expenses were deductible. Business related meals are still deductible up to 50% of the amount paid.
Meals provided by the employer to employees via eating facilities or otherwise on site at the work premises, are no longer deductible 100% by the employer. The deduction under the new law is now only 50% of the cost. This deduction is expected to be repealed completely after 2025. Note, however, that this fringe benefit will still be tax-free to employees.
Research and Development Credit and Deduction
The Research and Development Credit was unchanged in the new tax law. However, R&D expenditures must now be amortized over a five year period (15 years for foreign R&D expenses). This is in contrast to a full deduction in the year of the expense under the old law.
The deduction for interest expense is capped at 30% of adjusted taxable income (plus other criteria). However, there is an exception for small businesses. Those with average gross receipts of $25 million or less over the past three years are exempt from the new limitation.
Transportation Fringe Benefits
The deduction for businesses providing mass transit passes and vehicles to employees has been eliminated. However, employees will not be taxed on such benefits provided by their employers.
Temporary Family or Medical Leave Tax Credit
The new law allows for a credit of employer-paid wages for family or medical leave. The amount of the credit ranges from 12.5% to 25% based on the amount of wages paid by the employer.
This credit will only be available through 2019.
Net Operating Losses
A new loss deduction limit applies to NOLs incurred during tax years beginning after December 31, 2017. Such NOL deductions will be limited to 80% of taxable income.
The new law also generally eliminates the NOL carryback of two years for such losses, but allows an indefinite carryforward. The old law allowed a carryforward of up to 20 years.
Under the old law, if a corporation had average gross receipts in the previous three years that were $5 million or more, then the accrual method of accounting was mandated. The new law, however, raises this limit to $25 million. This way more corporations will be able to use the potentially more beneficial and less onerous cash method of accounting.
Pass-Through Entity Income Deduction
Owners of pass-through business entities can now potentially claim a 20% deduction of their “qualified business income ” (QBI). This includes income from a partnership (including an LLC), S corporation, a sole proprietorship (schedule C), or a real estate investor (schedule E). This deduction is created under the new Internal Revenue Code Section 199A.
Qualified business income includes active trade or business income and real estate activity income. It does not include investment income such as interest, dividends, and capital gains, or foreign earned income. Also excluded are wages or guaranteed payments received from a pass-through entity.
This deduction is limited to 20% of the excess of your taxable income over net capital gain income on your personal tax return. In other words, it is limited to the amount of your personal taxable income which is taxed at ordinary income tax rates (as opposed to preferential long term capital gain rates).
The QBI deduction is set to expire after 2025 if it is not extended by Congress.
QBI Deduction Limitations For Higher Income Taxpayers
Two additional limitations also apply for higher income taxpayers.
First, the deduction is limited by a “wage and capital” test in that it cannot exceed the greater of:
- Half the W-2 wages paid to employees of the business OR
- The sum of 25% of wages paid plus 2.5% of the unadjusted basis of tangible depreciable property held by the business at year end.
The deduction is also limited for pass-through entity income from most service oriented businesses.
However, these limitations above only apply if taxable income is above $157,500 (single) or $315,000 (married). The limitations begin to get phased in gradually above these levels. The limits are completely phased in once taxable income exceeds $207,500 (single) or $415,000 (married).
REIT Dividends and Qualified Publicly Traded Partnership (PTP) Income
The new tax law also allows a 20% tax deduction for qualified REIT dividends and publicly traded partnership (PTP) income. This is income from such sources that is otherwise subject to ordinary income tax rates, and not the preferential capital gain or qualified dividend rates.
This deduction is not subject to the wage and capital limitation discussed above.
Many observers see the new business tax law changes as separate from the individual tax cuts. They believe that individuals cannot really benefit from such changes in the business tax laws. But the reality is that the success of businesses can have wide and far reaching effects.
Businesses operate in communities. When they have more money (i.e. via tax cuts), they often look to grow and make more money by opening new stores, factories, and other business facilities. When this happens, jobs are created. Companies can also use excess funds from tax breaks to increase wages in order to attract and retain qualified workers.
Granted, small business owners and major shareholders of larger corporations will also benefit. But keep in mind that the larger corporations are to a great extent owned by average working class individuals. They generally own shares of these larger companies indirectly through mutual funds within their 401K pension plans at work, or their individual retirement accounts (IRAs), for example.
A more competitive business tax structure can also encourage new business creation. Part of this can potentially come from foreign investments into the United States. Foreign companies may find it more profitable to construct facilities and otherwise invest and do business in a country with a competitive tax system. More businesses also results in more competition, which acts to reduce prices for consumers.