On December 22, 2017, President Donald Trump signed into law H.R. 1 (the “Tax Act”), that enacted sweeping changes to the United States tax code. Below are some of the key sections of the Tax Act impacting businesses. These provisions are effective January 1, 2018, unless otherwise noted.
Corporate Tax Rate and Alternative Minimum Tax (“AMT”)
Currently, corporations are taxed at rates that range up to 35% and are additionally subject to the AMT. Corporations do not benefit from lower long-term capital gain rates. The Tax Act lowers the corporate tax rate to a flat 21% and eliminates the corporate AMT, both effective beginning in 2018 and on a permanent basis. In connection with the corporate rate cut, the Section 199 domestic manufacturing deduction is repealed going forward. The dividends received deduction is reduced from 80% to 65% and 70% to 50%, depending on ownership percentage.
Increased Cost Recovery (Bonus Depreciation)
Currently, taxpayers can immediately write off 50% of the cost of “qualified property” (generally, tangible personal property with a recovery period of 20 years or less). This ratio drops to 40% in 2018, 30% in 2019, and phases out after that.
The Tax Act initially allows full current expensing for property placed in service after September 27, 2017, reducing the percentage that may be expensed for property placed in service after January 1, 2023 by 20% each year until the deduction reaches 20% for property placed in service during 2026. The Tax Act also eliminates the requirement that the original use of the qualified property commence with the taxpayer, allowing taxpayers to fully expense purchases of used property.
Section 179 Expensing
The Tax Act increases the amount businesses can expense under IRC Section 179 from the current cost limit of $500,000 to $1,000,000 of Section 179 property (generally limited to most depreciable tangible personal property purchased for use in the active conduct of a trade or business). There is also an increase in the phase-out amount from $2,000,000 to $2,500,000, an amount which reduces the deduction dollar-for-dollar when the total Section 179 property placed in service in the current year by a taxpayer exceeds $2,500,000. The Tax Act indexes these amounts for inflation.
In addition, the Tax Act followed the Senate bill in expanding the definition of qualified real property for purposes of Section 179 to include all qualified improvement property and certain improvements (roofs, heating, ventilation, air-conditioning property, fire protection and alarm systems, and security systems) made to nonresidential real property.
Interest Deduction Limitations
IRC Section 163(j) was amended in the Tax Act to limit net interest deductions for all businesses to 30% of their adjusted taxable income. Adjusted taxable income is calculated as earnings before interest, income taxes, depreciation and amortization (“EBITDA”) for taxable years beginning before January 1, 2022. For subsequent years, adjusted taxable income is reduced by allowable deductions for depreciation, amortization, or depletion. Also, adjusted taxable income is calculated before any deductions under the new pass-through rules are taken into account. Disallowed amounts of interest expense would carry over indefinitely.
Small businesses – those with average annual gross receipts under $25 million (taken from the House version) – are exempted from the interest deduction limitation. The Tax Act also exempts floor plan financing – i.e., interest expense on debt used to finance the acquisition of motor vehicles held for sale or lease.
Real property trades or businesses (defined as “any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business”) can also elect out of the Section 163(j) limitation. Electing out would require the use of the Alternative Depreciation System (“ADS”) to depreciate nonresidential real property (40 years), residential rental property (30 years reduced from 40), and qualified improvement property (20 years per the Conference Statement).
Net Operating Losses (“NOL”)
The Tax Act generally prohibits NOL carrybacks (with an exception for farming NOLs). The NOL deduction would be limited to 80% of taxable income. NOLs could now be carried forward indefinitely, and NOLs incurred in taxable years beginning after December 31, 2017 will be adjusted for inflation.
Prior to the Tax Act, businesses could deduct up to 50% of expenses paid or incurred for meals and entertainment directly related to the active conduct of the business. Under the Tax Act, no deduction is 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. Only the deduction for 50% of food and beverage expenses associated with operating a trade or business generally would be retained. The Tax Act does enlarge this deduction to include providing meals to employees through an eating facility that meets the requirements for de minimis fringes and for the convenience of the employer, which would sunset after December 31, 2025. The Tax Act also disallows deductions for providing qualified transportation fringe benefits to employees.
This article addresses some of the more substantial tax items of interest to businesses in the Tax Act. These changes may provide significant benefits for companies going forward and offer current planning opportunities before year-end.
If you have questions or concerns with how any of these provisions will impact you or your business, please do not hesitate to contact us.