With the new tax law comes many changes that will impact businesses in 2018 and beyond. The following is far from a comprehensive list of changes. But it may help to identify some changes that you may need to look further into and consult your tax adviser on:
- C Corporation Tax Rate: Beginning in 2018, the C Corporation tax rate is changed to 20%. Previously the top tax rate was 39%. This is of course great news for companies already organized as C Corporations, as they will be subject to a lower tax rate going forward. Going forward, for both existing companies and new businesses, this change will have a significant impact on entity choice. Previously, with the higher tax rate, in general C Corporation status was not advantageous for a lot of small businesses. Many businesses were better off organizing as partnerships or electing S Corporation status and having income flow through to the individual level. The lower tax rate now makes C Corporation status a lot more advantageous from a tax perspective. Businesses and business owners will need to consider a variety of factors when deciding on the type of entity to select, including the owner’s personal income tax situation, whether the business will qualify for the 20% Qualified Business Income Deduction (discussed further below), what the exit strategy is, and how much profit is expected to be generated and left inside the company. The analysis may prove to be quite complex and could of course change if the existing laws are replaced during the lifetime of the business.
- Qualified Business Income Deduction: We will only scratch the surface of this deduction here, but for owners of business other than C Corporations, there is a new deduction that can be taken against flow-through income. The deduction involves some tricky calculations, but in general the deduction will be limited to 20% of the individual’s income tax. However there in many situations where it will be lower than that. There will be two key determinations when evaluating the deduction. The first will be whether the taxpayer falls above or below the income level where the deduction begins to phase out for certain types of businesses. If you fall below this level, then you won’t need to evaluate whether your business falls under the definition of a service corporation as defined in the new regulations. If you do fall above this level, then you will need to determine whether your business qualifies for the deduction or is partially or fully excluded. The regulations state that businesses involving the performance of services in the fields of law, accounting, financial services, and consulting, to name a few examples, do not receive the deduction if their income falls above certain thresholds stated in the regulations.
- Meals & Entertainment: Under the new regulations, entertainment expenses are no longer deductible. Meals will still be 50% deductible, depending on the nature of the meal. This makes expenditures like sports tickets and other entertainment less favorable from a tax perspective compared to other forms of expenses, and therefore many companies may want to evaluate their marketing and other budgets moving forward.
- Net Operating Loss (NOL) Carrybacks and Carryforwards: The NOL carryback is eliminated starting in 2018, while the NOL Carryforward can now be carried forward indefinitely. The carryforward however can only be applied against 80% of taxable income, whereas it could previously be applied against 100% of taxable income. While income and losses may be out of the owner’s control in some situations, tax planning should factor in these changes where possible. Let’s take an example of a business that has income in both 2018 and 2019. Midway through 2020, the business is operating at a loss, but has some tax planning options to either push the loss further or move to a break-even position. Under the old regulations, there would be tax advantages to increasing the loss in 2020, because the loss could be carried back and applied against income from 2018 and 2019. Under the new regulations, the loss can only be carried forward, so there may be less incentive to move to a larger loss position, especially in cases where the business may have operating or funding reasons for not wanting to show a large loss on their tax return.
- Section 179 Expansion and Bonus Depreciation: The new law increased the amount you can deduct under Section 179 from $500,000 to $1M. The phase-out level also increased from $2.0M to $2.5M. Meanwhile, the bonus depreciation deduction increased from 50% to 100% of the cost of property purchased and was also expanded to include certain used property. Previously, the property had to be new to qualify for bonus depreciation. These provisions were already very favorable for taxpayers and become increasingly so with the new changes. Businesses considering large purchases will want to consider if the purchases will qualify for the deduction and how it will impact their overall tax situation. It could significantly reduce taxes if companies make purchases before the end of the tax year, assuming there is cash or financing available to make the purchase.
- Research & Development (R&D) Expenses: Beginning in 2021, R&D expenses must be capitalized and amortized over a period of five years. Businesses will no longer be able to deduct the expenses when incurred. This is unfavorable for businesses that have a profit but are incurring substantial R&D expenses.
- Business Interest Deduction: This change only applies to companies with average gross receipts greater than $25 million, but the new regulations limit the amount of interest a business can deduct. This may require some debt-heavy companies to reconsider their capital structure, as companies with high debt levels could see their current structure become less tax advantageous due to the new limitations.
Please consult a tax advisor with any questions and remember that there are a lot of other changes with the new tax bill that need to be considered.