Business Year-End Planning after the Tax Cuts and Jobs Act
Business Owners Face Opportunities and Challenges In Order To Comply With the New Act.
As the year concludes, business owners are faced with the opportunity and challenge of evaluating their current year operations and future expectations to determine how to best take advantage or minimize the downside of the numerous changes in tax law taking effect as a result of the Tax Cut and Jobs Act (or “TCJA” or “the Act”). While there have been many updates for the 2018 tax year, the uncertainty as to the interpretation of many of the provisions of TCJA requires business owners and their tax advisors to remain vigilant and up-to-date in order to ensure compliance and the maximization of tax benefits.
Business owners should consider the following tax planning tips based on the tax provisions modified as a result of TCJA and those provisions in place prior to the Act.
- TCJA reduces the C-corporation tax rate to a flat 21% for tax years beginning after December 31, 2017. (The 21% rate will be prorated for fiscal year filers). Taxpayers may consider converting their pass-through entities to C-corporation structure to take advantage of the decreased corporate tax rate.
- TCJA repeals the corporate alternative minimum tax (AMT) for tax years beginning after December 31, 2017, and continues to allow the prior year minimum tax credit to offset the taxpayer’s regular tax liability. For tax years beginning after 2017, and before 2022, the prior year minimum tax credit carryover is refundable. Corporations with prior-year minimum tax credits should consider adjusting their 2018 fourth quarter estimated payments or extension payments to account for these amounts.
- Bonus depreciation has been extended and will now allow a 100% deduction for property acquired and placed into service after September 27, 2017. The definition of qualified property has been also been expanded to include purchased used property. Taxpayers are currently able to elect to deduct as an expense, rather than depreciate the cost of, certain new or used business assets placed in service during the year.
- Taxpayers who have acquired, or are acquiring, real estate for business use should consider having a cost segregation study performed. Generally, property placed in service after September 27, 2017, with a class life of 20 years or less will be eligible for 100% bonus depreciation, whereas non-residential property is usually characterized as 39-year property not eligible for bonus depreciation. A cost segregation study can assist real estate owners in allocating the proper costs of acquisitions among the proper class lives, so that depreciation can be expedited on certain assets.
- The de minim is safe harbor repair threshold remains at $2,500 for most taxpayers and $5,000 for taxpayers with applicable (i.e., audited) financial statements. Under this safe harbor, eligible taxpayers may deduct as an expense, rather than depreciate, the cost of qualified property acquired or repaired.
- The Research and Development Tax Credit is permanent and allows businesses engaging in certain research activities and incurring qualified research expenses to receive a tax credit to offset federal business tax liability and, in the case of a pass- through entity, to offset personal tax liability. Qualified small businesses may also still elect to utilize the credit against FICA payroll taxes.
- Taxpayers with average annual gross receipts of $25 million or less for the prior three taxable years are now permitted to use the cash method of accounting, are exempt from the inventory uniform capitalization (UNICAP) rules, and are exempt from the requirement to use the percentage-of-completion accounting method for long-term construction contracts to be completed within two years. Previously, the average gross receipts threshold was $10 million.
- Cash basis taxpayers may accelerate deductions by prepaying certain expenses before year-end. Also, credit card charges incurred before year-end may be deducted in 2018 and paid in 2019.
- Cash basis taxpayers should consider deferring income to 2019 as long as the income is not actually or constructively received.
- Accrual basis taxpayers may generally deduct cash payments made within 2 ½ months after year-end for compensation, bonus, and long-term incentive plans.
- Under TCJA, a deduction is no longer allowed for entertainment, amusement, or recreation; membership dues for a club organized for business, pleasure, recreation, or other social purposes; or a facility used in connection with any of the above. The deduction for 50% of food and beverage expenses associated with operating a trade or business generally is retained. The Act now limits to 50% employer expenses associated with providing food and beverages to employees through an eating facility meeting de minim is fringe requirements. Taxpayers should review these updates as a result of TCJA to analyze and possibly decrease their entertainment budgets in favor of other expenses that will be deductible.
- TCJA disallows deductions for expenses associated with providing any qualified transportation fringe to employees and, except for ensuring employee safety, any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of employment. These amendments generally apply to amounts paid or incurred after December 31, 2017.
- Individual owners of pass-through entities should review and determine if there is sufficient tax basis to deduct 2018 business losses at the individual level. Also, it is important to review if there are any tax implications from distributions taken by owners of pass-through entities in 2018. Action should be taken before year-end if additional tax basis is necessary for losses or distributions.
- Individual owners of pass-through entities should also take into account that the IRS now disallows an excess business loss which becomes part of the taxpayer’s net operating loss carryover to the following year. An excess business loss for the tax year is the excess of the taxpayer’s aggregate deductions attributable to the taxpayer’s trades or businesses, over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount ($500,000 for married taxpayers filing jointly and $250,000 for all other taxpayers, indexed for inflation). If a taxpayer is planning to offset other earnings with business losses, the taxpayer must consider that potentially only a portion of these business losses will be utilized in the current year.
- Taxpayers may still consider various deferral techniques such as installment sales and like-kind exchanges, but it is important to note that the Act now limits the non-recognition of gain or loss to like-kind exchanges of real property that is not held primarily for sale. This amendment generally applies to exchanges completed after December 31, 2017.
- Taxpayers should review tax-attribute carryovers, such as net operating losses, capital losses, tax credits, and charitable contributions to determine if there are any expiring carryovers and to what extent carryovers can or should be used in 2018. The NOL deduction limit for NOLs arising in 2018 is now 80% of taxable income, computed without regard to the NOL deduction, and provides that amounts carried over to later tax years are adjusted to take into account this limitation. TCJA also eliminates NOL carrybacks and allows unused NOLs to be carried forward indefinitely.
- Individual taxpayers that use a portion of their homes for business purposes should consider deducting expenses incurred for that portion of the home. The deduction is limited to business income; however, disallowed expenses may carry forward to future years.
- For tax years beginning after December 31, 2017, and before January 1, 2026, taxpayers who have domestic “qualified business income” (QBI) from a partnership, S corporation, or sole proprietorship are entitled to a deduction equal to: (1) the lesser of the combined qualified business income amount of the taxpayer or 20% of taxable income (reduced by net capital gain), plus (2) the lesser of 20% of qualified cooperative dividends or taxable income (reduced by net capital gain). The deduction reduces taxable income, not adjusted gross income, and eligible taxpayers are entitled to the deduction whether or not they itemize. Shareholders of businesses operating as S-corporations should first determine their eligibility for the 20% QBI deduction and then review year-end compensation to distribute business profits, as well as meet 2018 estimated tax requirements through final income tax withholdings.
- The Act limits the deduction for net interest expense incurred by a business to the sum of business interest income, 30% of adjusted taxable income, and floor plan financing interest. Businesses with average annual gross receipts of $25 million or less are exempt from this limitation. Disallowed interest may be carried forward indefinitely. Taxpayers should take into account interest expense limitations post-TJCA when deciding between equity and debt financing.
- The Act provides a 100% deduction for the foreign-source portion of dividends received from “specified 10-percent owned foreign corporations” by U.S. corporate shareholders, subject to a one- year holding period. Corporations are no longer required to keep foreign earnings offshore and should repatriate cash as they deem necessary to support business operations.
As year-end approaches, it is important for business owners and individual taxpayers to be in touch with their tax advisors. The 2018 tax year will be the first time many of the new provisions from TCJA will be implemented, and there are myriad tax decisions that must be considered.
While this planning guide reflects many action items to review prior to year-end, below is a short list of items to consider:
- Review whether converting to another entity type will provide an overall tax benefit.
- Review opportunities to elect 100% bonus depreciation.
- Review tax basis in pass-through entities and total estimated business losses to determine whether 2018 business losses will be deductible.
- Review compensation amounts to minimize the effective tax rate.
- Evaluate whether foreign cash should be repatriated to support onshore business operations.