The Tax Cuts and Jobs (TCJA) has many effects and the impacts felt vary from business to business, depending on the nature of the business as well the structure. Manufacturers and distributors will most likely be impacted by a lower tax rate if they are a corporation or an individual (if they have stake in a pass-through entity). They will also be impacted by the changes in alternative minimum tax (AMT), as well as the expansion of IRS Sec. 179 and bonus depreciation for the first year.
There was a permanent reduction of federal tax rate for corporations consolidating the staggered tax brackets (15%, 25%, 34%, or 35%) to a flat 21%. While a flat tax is beneficial for entities paying more than the new tax rate, it is an unfavorable increase for entities that were in 15% tax bracket.
However, some changes in the TCJA may offer hope to those experiencing an increase in their tax rate. For example, the TCJA allows entities that have average annual gross receipts under $25 million for the three preceding tax years to file taxes utilizing the cash method, as long as the entity is not a tax shelter. The option to use the cash method of accounting gives room for tax planning by deferring revenue recognition and accelerating expenses when compared to the accrual method of accounting. The Act also expanded the types of entities that can use the simplified inventory accounting method from those with average annual gross receipts for the three preceding tax years of $10 million to $25 million. Simplified inventory accounting method makes it less burdensome for businesses to account for inventories by eliminating the requirement for costs associated with producing and buying goods for resale to be capitalized.
Individual owners of pass-through entities are eligible for a deduction of up to 20% of the qualified business income (QBI). This incentive is to level the field for those filing partnership tax returns given the benefits that fall to C corporations. While the flat tax rate for corporations is permanent, the QBI deduction is only available through 2025. QBI deductions are limited to the greater of 50% of the W-2 wages paid to the employees or the sum of 25% of W-2 wages plus 2.5% of cost any qualified property. For the individuals whose income exceeds $157,500 (if filing single or $315,000 if married filing jointly), there are limitations on the QBI deductions.
AMT was permanently repealed for corporations under the TCJA. Before the repeal, corporations were subject to 20% AMT less any foreign tax credits. AMT exemptions for individuals also increased under TCJA, which will help pass-through business owners.
Another big change to TCJA is the expansion of IRS Sec. 179 and bonus depreciation deduction. Sec. 179 expense increased from $510,000 to $1 million and phase-out threshold increased to $2.5 million from $2.03 million in 2017. These amounts will be adjusted annually for inflation. Also, any qualified property that was placed in service between September 28, 2017 and December 31, 2022 qualifies for 100% bonus depreciation. Bonus depreciation will start phasing out in 2023 with 80% depreciation deduction, 60% depreciation deduction in 2024, 40% deduction in 2025, and 20% deduction in 2026.
There are several other changes in TCJA that manufacturers and distributors should look out for such as interest expense deductions limitations, net operating losses (NOLs), business entertainment deduction, and also the repeal of domestic production deduction under the IRS Sec. 199.
This information can be cumbersome and somewhat overwhelming when dealing with new tax changes. It is always a good rule of thumb to converse with your local accountant about any updated tax information.
Our tax professionals are well-versed in the new tax law changes and are here to assist you and your business’ continue success.