The Tax Cuts and Jobs Act (The Act) is a piece of legislation that was first passed by the House on November 16, 2017. Only one month later, both the House and the Senate have passed a unified version of tax reform that will modify tax policy for the next several years. These changes range from reducing both corporate and individual tax rates as well as international taxation. On December 22, 2017, President Trump officially signed it into law. Below is a brief analysis of the key points included in The Act.
Corporate Tax Rates
The corporate tax rate is a flat 21% for tax years beginning after Dec. 31, 2017.
Dividends-Received Deduction Percentages
The Act modified the dividends-received deduction. The 70% dividends received deduction is lowered to 50% and the 80% dividends received deduction is lowered to 65% for tax years starting after Dec. 31, 2017.
Alternative Minimum Tax
For tax years beginning after Dec. 31, 2017, the corporate AMT is repealed.
Alternative Minimum Tax Credit Carryforward
For tax years beginning after 2017 and before 2022, the AMT credit is refundable. It is available to offset regular tax liability equal to 50% (increased to 100% for tax years beginning in 2021) of the amount over the minimum tax credit for the tax year in excess of the credit allowable for the year against regular tax liability. The entire amount of the minimum tax credit will be allowed in tax years beginning before 2022.
Increased Code 179 Expensing
Beginning after Dec. 31, 2017, a taxpayer may expense under Code Sec. 179 $1 million, and the phase-out threshold amount is increased to $2.5 million for property placed in service during the year. Tax years beginning after 2018 are indexed for inflation, which includes the $25,000 sport utility vehicle limitation. Property is treated as acquired on the date on which a written binding contract is entered into for such. A new addition to Section 179 expensing is the inclusion of certain depreciable, tangible personal property used predominantly to furnish lodging, or in connection with furnishing lodging. Also, qualified real property that is eligible for section 179 expensing is expanded to include improvements to nonresidential real property after the date such property was first placed in service:
- Heating, ventilation, and air-conditioning property
- Fire protection and alarm systems
- Security systems.
Temporary 100% Cost Recovery of Qualifying Business Assets
There is now a 100% first-year deduction (bonus depreciation) equal to the adjusted basis that is allowed for qualified property acquired (both new and used) which is placed in service after Sept. 27, 2017, and before Jan. 1, 2023 (after Sept. 27, 2017, and before Jan. 1, 2024, for certain property with longer production periods).
For tax years after Dec. 31, 2022, the first-year bonus depreciation deduction phases down:
- 80% for property placed in service after Dec. 31, 2022 and before Jan. 1, 2024.
- 60% for property placed in service after Dec. 31, 2023 and before Jan. 1, 2025.
- 40% for property placed in service after Dec. 31, 2024 and before Jan. 1, 2026.
- 20% for property placed in service after Dec. 31, 2025 and before Jan. 1, 2027.
For the first tax year ending after Sept. 27, 2017, taxpayers may elect to use the 50% bonus first-year depreciation (instead of the 100% first-year bonus.)
Luxury Automobile Depreciation Limits
Passenger automobiles (listed property) placed in service after Dec. 31, 2017 that do not claim the additional first-year depreciation deduction under Code Sec. 168(k) have a maximum allowable depreciation increases as follows
- $10,000 for the year in which the vehicle is placed in service,
- $16,000 for the second year,
- $9,600 for the third year, and
- $5,760 for the fourth and later years in the recovery period.
These dollar limits are indexed for inflation for passenger automobiles placed in service after 2018. The maximum first-year depreciation allowance remains at $8,000 for passenger autos eligible for bonus first-year depreciation. Note: computer or peripheral equipment is removed from the listed property definition.
Qualified Improvement Property
For property placed in service after Dec. 31, 2017, there will no longer be separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property. Instead, there will be a general 15-year recovery period and straight-line depreciation provided for qualified improvement property, and a 20-year ADS recovery period provided for such property.
Going forward, qualified improvement property placed in service after Dec. 31, 2017, is generally depreciable over 15 years using the straight-line method and half-year convention. The Act disregards several items:
- whether or not the improvements are property subject to a lease,
- placed in service more than three years after the date the building was first placed in service, or,
- made to a restaurant building.
The general recovery period for nonresidential rental and residential rental property remains at 39 and 27.5 years, respectively.
Limits on Deduction of Business Interest
For tax years beginning after Dec. 31, 2017, no business, regardless of form, will be allowed a deduction for net interest expense in excess of 30% of the business's adjusted taxable income. The net interest expense disallowance is determined at the corporate level, with the requirement that pass-through entitles follow the same limitation as corporations at the entity level instead of at the partner level.
For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2022, adjusted taxable income is computed without regard to deductions allowable for depreciation, amortization, or depletion.
Taxpayers (other than tax shelters) with average annual gross receipts for the three-tax year period, ending with the prior taxable year that do not exceed $25 million are exempt from these rules.
Modification of Net Operating Loss Deduction
Losses that arise in tax years beginning after Dec. 31, 2017 will have a Net Operating Loss ("NOL") deduction that is limited to 80% of taxable income (determined before the deduction). Losses incurred prior to Dec. 31, 2017 are 100% deductible. Adjust carryovers to other years to take account of this limitation. For NOLs arising in tax years ending after Dec. 31, 2017, there is no longer a two-year carryback, except in the case of certain losses incurred in the trade or business of farming.
Domestic Production Activities Deduction Repealed
For tax years beginning after Dec. 31, 2017, the DPAD is repealed for non-corporate taxpayers and for corporate taxpayers after Dec. 31, 2018.
Like-Kind Exchange Treatment Limited
For transfers after Dec. 31, 2017, in general, the rule allowing the deferral of gain on like-kind exchanges is modified to only allow like-kind exchanges for real property (land, buildings, homes. etc.) that is not held primarily for sale.
Five-Year Writeoff of Specified R&E Expenses
Beginning after Dec. 31, 2021, amounts paid or incurred for "specified R&E expenses" must be capitalized and amortized over a 5-year period (15 years if foreign activity). The start date will be midyear in the tax year in which the specified R&E expenses were paid or incurred.
Employer's Deduction for Fringe Benefits
Entertainment expenses incurred after Dec. 31, 2017 are disallowed. This eliminates the determination of whether such expenses are sufficiently business related. However, the 50% deduction of business meals is retained. It will be expanded to meals provided through an in-house cafeteria or otherwise on the premises of the employer. Deductions for employee transportation fringe benefits (e.g., parking and mass transit) are denied, but the exclusion from income for such benefits received by an employee is retained. No deduction is allowed for transportation expenses that are the equivalent of commuting for employees (e.g., between the employee's home and the workplace), except when paid for the employees safety.
No Deduction for Amounts Paid For Sexual Harassment Subject to Nondisclosure Agreement
For amounts paid or incurred after the enactment date of The Act, if a nondisclosure agreement exists, no deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse.
Employee Achievement Awards
Employee achievement awards, including items of tangible personal property, are excludable to the extent the employer can deduct the cost of the award, which is generally limited to $400 for any one employee, or $1,600 for a "qualified plan award."
A new definition of "tangible personal property" is provided for tax years after Dec. 31, 2017. Tangible personal property does not include cash, cash equivalents, gifts cards, gift coupons, gift certificates (other than where from the employer pre-selected or pre-approved a limited selection), vacations, meals, lodging, tickets for theatre or sporting events, stock, bonds or similar items and other non-tangible personal property.
New Credit for Employer-Paid Family and Medical Leave
Businesses can claim a general business credit equal to 12.5% of the amount of wages paid to qualifying employees on family and medical leave ("FMLA"), if the rate of payment is 50% of the wages normally paid. For wages paid in excess of 50%, the credit will increase by .25 percentage points, with a max additional credit of 25% of the total wages. This is for wages paid in tax years beginning after Dec. 31, 2017, but before Jan. 1, 2020.
Small Business Thresholds
The requirements to use the following methods of account has changed. The Act increased the three year average gross receipts test to $25 million for several items:
- Cash Method of Accounting for taxpayers who are C Corporations or partnerships with C corporate partners.
- Accounting for Inventories
- Inventory Capitalization (UNICAP)
- Long Term Contract Accounting (requirement to use percentage of completion)
All of the changes above are a change in accounting method, except for long term contract accounting which is based on a cutoff basis.
Repeal of Partnership Technical Termination
For tax years beginning after Dec. 31, 2017, the rule for the technical termination of partnerships (greater than 50% change in ownership interest) is repealed. This doesn't change the pre-Act law: a partnership is considered terminated if no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership.
Qualifying Beneficiaries of an ESBT
Effective on Jan. 1, 2018, the Act allows a nonresident alien individual to be a potential current beneficiary of an ESBT.
Charitable Contribution Deduction for ESBTs
For tax years beginning after Dec. 31, 2017, the Act provides that the charitable contribution deduction of an ESBT is determined by the rules applicable to individuals instead of the rules applicable to trusts. Therefore, the percentage limitations and carryforward provisions applicable to individuals apply to charitable contributions made by the portion of an ESBT holding S corporation stock.
Excise Tax on Excess Tax-Exempt Organization Executive Compensation
For tax years beginning after Dec. 31, 2017, a tax-exempt organization is subject to a tax at the corporate tax rate (21%) for the sum of:
(1) The remuneration (other than an excess parachute payment) in excess of $1 million paid to a covered employee by an applicable tax-exempt organization for a tax year; and
(2) Any excess parachute payment (as newly defined) paid by the applicable tax-exempt organization to a covered employee.
A covered employee (including any former employee), is one of an applicable tax-exempt organization if the employee is one of the five highest compensated employees of the organization for the tax year or was a covered employee of the organization (or a predecessor) for any preceding tax year beginning after Dec. 31, 2016. Remuneration is treated as paid when there is no substantial risk of forfeiture of the rights to such remuneration.
UBTI Separately Computed for Each Trade or Business Activity
The Act modified UBTI taxation regarding losses from one unrelated trade or business may not be used to offset income produced from another unrelated trade or business. There is an exception for NOLs arising in a tax year beginning before Jan. 1, 2018, which are carried forward. Going forward any gains and losses must be calculated and applied separately.