The new law contains a treasure trove for businesses that qualify for tax breaks. Most companies and business owners will see lower tax bills under the new tax law, but there are a number of tax breaks that were eliminated or reduced to make room for the new provisions. Here are the most important changes in the new law that will affect businesses and their owners.
21% Corporate Tax Rate
Previously, C corporations paid graduated federal income tax rates and personal service corporations (PSCs) paid a flat 35% rate. For tax years beginning in 2018, C corporations pay a flat 21% corporate rate, and that rate also applies to PSCs. This change does not expire.
Reduced Corporate Dividends Deduction
Previously, C corporations that received dividends from other corporations were entitled to partially deduct those dividends. If the corporation owned at least 20% of the stock of another corporation, an 80% deduction applied. Otherwise, the deduction was 70% of dividends received.
For tax years beginning in 2018, the TCJA reduces the 80% deduction to 65% and the 70% deduction to 50%. These reductions are intended to maintain the effective tax rate on these dividends. This change does not expire.
Corporate Alternative Minimum Tax Repealed
Before the changes, the corporate alternative minimum tax (AMT) was imposed at a 20% rate. The new law repeals the corporate AMT. For corporations with an AMT credit, the new law allows corporations to fully use the credit carryovers in their 2018–2021 tax years. This change does not expire.
New Section 199A Deduction for Pass-Through Businesses
Net taxable income from pass-through business entities is passed through to owners who pay tax at their standard rates. Pass-through businesses include businesses treated as sole proprietorships, partnerships, and S corporations for tax purposes.
For tax years beginning in 2018 and before 2026, owners of these entities (other than C corporations) will receive a new deduction based on qualified business income (QBI). The QBI deduction does not reduce adjusted gross income (AGI). Instead it is an additional deduction applied after the standard deduction to reduce taxable income.
The deduction generally equals 20% of QBI, subject to limits. As discussed below, the limitations based on W-2 wages and/or depreciable property only apply to taxpayers with taxable income (before application of this new deduction) over the threshold amounts.
The threshold amount of taxable income for a joint return is $315,000. It is $157,500 for all others. Above those income levels, the W-2 wage limitation and Service Business limitation are phased in over a $100,000 range for joint filers and $50,000 range for all others. These amounts are adjusted for inflation.
Qualified Business Income
QBI is generally defined as the net amount of qualified items of income, gain, deduction and loss from any qualified business. QBI does not include certain investment items, reasonable compensation paid to an owner for services rendered to the business or any guaranteed payments to a partner for services rendered to the partnership (or LLC).
W-2 Wage Limitation
For owners with taxable income over the threshold amounts, the QBI deduction for each business generally cannot exceed the greater of the owner’s share of:
- 50% of the amount of W-2 wages paid to employees, or
- The sum of 25% of W-2 wages plus 2.5% of the cost of qualified property.
Qualified property is the depreciable tangible property (including real estate) owned by a qualified business as of year-end and used by the business at any point during the tax year for the production of qualified business income.
Service Business Limitation
The QBI deduction generally is not available for income from specified service businesses. These include most professional practices other than engineering and architecture and businesses that involve investment-type services, such as brokerage and investment advisory services. The service business limitation does not apply below the threshold amounts.
New Limits on Business Interest Deductions
Under the new law, businesses generally cannot deduct interest expenses in excess of 30% of “adjusted taxable income,” starting with tax years in 2018. For S corporations, partnerships and LLCs that are treated as partnerships for tax purposes, this limit is applied at the entity level rather than at the owner level. This change does not expire.
For tax years beginning in 2018 through 2021, adjusted taxable income is calculated by adding back allowable deductions for depreciation, amortization and depletion. After that, these amounts are not added back in calculating adjusted taxable income.
A business interest expense that is disallowed under this limitation is treated as business interest arising in the following taxable year. Amounts that cannot be deducted in the current year can generally be carried forward indefinitely.
Taxpayers (other than tax shelters) with average annual gross receipts of $25 million or less for the three previous tax years are exempt from the interest deduction limitation. Some other taxpayers are also exempt. For example, real property businesses that elect to use a slower depreciation method for their real property. Another exemption applies to floor plan financing (for example, financing by dealers to acquire motor vehicles, boats or farm machinery that will be sold or leased to customers).
Reduced or Eliminated Employer Deductions for Business-Related Meals and Entertainment
Under the new law, for amounts paid or incurred after December 31, 2017, deductions for business-related entertainment expenses are disallowed. Meal expenses incurred while traveling on business are still 50% deductible, but the 50% disallowance rule will now also apply to meals provided via an on-premise cafeteria or otherwise on the employer’s premises for the convenience of the employer. After 2025, the cost of meals provided through an on-premise cafeteria or otherwise on the employer’s premises will be nondeductible. This change does not expire.
Changes to Some Employee Fringe Benefits
The new law disallows employer deductions for the cost of providing commuting transportation to an employee (such as hiring a car service), unless the transportation is necessary for the employee’s safety. It also eliminates employer deductions for the cost of providing qualified employee transportation fringe benefits (for example, parking allowances, mass transit passes and van pooling), but those benefits are still tax-free to recipient employees. This change does not expire.
Here are some of the other business-related changes:
- NOL Limit
The maximum amount of taxable income that can be offset with net operating loss (NOL) deductions is generally reduced from 100% to 80%. In addition, NOLs can no longer be carried back to an earlier tax year (except for certain farming losses). NOLs can be carried forward indefinitely. This change does not expire.
- Business Loss Limit
A new limitation applies to deductions for “excess business losses” incurred by non-corporate taxpayers. No more than $500,000 of business losses may be deducted against non-business income on a joint return ($250,000 for others). Losses that are disallowed under this rule are carried forward to later tax years. These amounts are indexed for inflation and the limit expires after Dec. 31, 2025.
- Generous Asset Expensing and Depreciation
The maximum Section 179 deduction increases to $1 million, and the phaseout threshold amount is increased to $2.5 million (from $510,000 and $2.03 million respectively). There are also much better first-year bonus depreciation rules through 2027, including 100% bonus depreciation for qualified property placed in service before Jan. 1, 2023.
- DPAD Eliminated
The Section 199 deduction, also commonly referred to as the domestic production activities deduction or manufacturers’ deduction, is eliminated for tax years beginning after December 31, 2017, for non-corporate taxpayers and for tax years beginning after December 31, 2018, for C corporation taxpayers. This change does not expire.
- 1031 Exchanges Limited
The Section 1031 rules that allow tax-deferred exchanges of appreciated like-kind property is allowed only for real estate for exchanges completed after December 31, 2017. This change does not expire.
- Compensation Deductions Limited
The deduction for amounts paid to principal executive officers generally cannot exceed $1 million per year, subject to a transition rule for amounts paid under binding contracts that were in effect as of November 2, 2017. The new law applies this limit to equity compensation as well. This change does not expire.
- Specified R&D Expenses
R&D must be capitalized and amortized over five years, or 15 years if the R&D is conducted outside the United States instead of being deducted currently. This begins with tax years beginning after December 31, 2021 and does not expire.
The new law is the largest overhaul of the tax code in more than 30 years, and these are only the highlights.
For further information, contact Thomas R. Vance or your ORBA advisor at 312.670.7444.