Tax Reform Q&AJan 30, 2018 11:00AM ● By Kiki Wooley
Corporate Tax Changes
Q: How did corporate tax rates change and what will be the potential effects on corporations from this change?
A: Generally touted as the centerpiece of this legislation, the corporate tax rate reduction will have two major effects. First, it will drastically reduce the amount of tax paid by C Corporations. Under old law, C Corporations paid tax on a graduated rate schedule topping out at 35 percent. Under the new law, the corporate tax rate is reduced to a flat 21 percent for all C corporations, regardless of income, and the corporate AMT is repealed. High profile companies such as Walmart, Darden & Sonic have recently announced their plans to use the tax savings they will see from the rate reductions. They, and many other companies, plan to invest in their workforce and new technology.
Second, the corporate rate reduction will cause many pass-through entity owners to re-assess their decision to, in fact, be a pass-through entity any longer. One motivation, among several, for choosing pass-through status has generally been the high tax rate when you combine corporate level tax at 35% with the second layer of tax on dividends paid to owners—up to another 23.8 percent for the highest income earners. With the reduction in corporate tax rates, some pass-through entity owners might choose to convert to C Corporation status to take advantage of the lower rate. This might prove beneficial if owners plan to re-invest profits into the business rather than distributing most of them as dividends. For companies that generally pay most of their earnings to the owners, though, pass-through status might still be the way to go. Of course, other factors, both tax-related and non-tax, often play into the decision to be a C Corporation or pass-through entity so this is only one to consider.
Q: What is this new pass-through deduction I’ve heard about recently?
A: The new provision offered to “Main Street” businesses allows a deduction of up to 20 percent of pass-through entity income—income from S Corporations, partnerships, and sole proprietorships using Schedule C.
As with most taxpayer-friendly provisions, Congress has imposed all types of limitations and phase outs on this new 20 percent deduction. So, here’s how it works. If your overall taxable income is less than $157,500 if filing single or $315,000 if filing joint (you have to include your spouse’s income too) then you generally have no restrictions on this deduction. Take 20 percent of your pass-through business income and that figure reduces your taxable income dollar for dollar. If you have more than one business, then add them all together (net profits and losses) to calculate your deduction.
It gets trickier if your income is above the $157,500/$315,000 limit. First, you will probably not be able to take the deduction if your pass-through income is from a professional service type of business such as law, consulting, medical, accounting, or anything else where the reputation of the service provider is a major factor in the business. Architects and engineers are specifically exempt from this rule. Second, if you break through the income limits, you might face an alternate formula for calculating the allowable deduction. This alternate formula potentially limits the deduction based on your total W-2 wages and the cost of your real estate, furniture, fixtures, and equipment. So, businesses dependent heavily on labor and property to make profits will generally not be affected by the limitations.
Q: Did depreciation rules for property and equipment purchases change under the new law?
A: Yes, the new law includes two major changes to depreciation. First, Section 179 expensing allows a business to immediately deduct up to $510,000 of the cost of personal property put in service each year. It’s a no-questions-asked, simplified method to match your deductions with your cash outlay. To qualify, you must have taxable income (it can’t bring your income below zero in a given year) and have purchased less than $2,000,000 worth of new property during the year. The new tax law increases the limits, allows more types of property to qualify for the deduction, and indexes the limits for inflation starting in 2019.
Max Deduction allowable
Deduction phaseout begins at
2019 & later
$1,000,000 + inflation adj.
$2,500,000 + inflation adj.
As seen in the chart above, the Section 179 deduction limit nearly doubles from 2017 to 2018, the phaseout amount increases significantly, and they’re both indexed for inflation in future years. Also, old Section 179 law did not allow the special deduction for most types of real estate components unless they were part of a narrowly-defined group of leasehold improvements. The new law, though, greatly expands the type of real property improvements that qualify for the Section 179 deduction. It now includes all interior leasehold improvements made after the property has been placed in service as well as the following costs incurred to improve a structure:
o heating, ventilation, and air-conditioning property
o fire protection and alarm systems
o security systems
To be clear, these costs cannot be expensed under Section 179 if they are incurred as part of new construction or an upfit of a property that has not yet been placed in service. To qualify, the improvements must be made in a later year.
Second, the new law expands an expensing provision called “bonus depreciation.” Bonus depreciation is similar to Section 179 expensing in that it allows items to be deducted much more quickly than normal tax depreciation rules. Bonus depreciation differs from Section 179, though, in that it is neither subject to dollar limits for the deduction, nor is it subject to phaseouts based on the dollar value of property placed in service during the year. These factors allow it to be used by larger companies that put more than $2.5 million of property in service each year. Also, most state tax systems do not allow bonus depreciation, so you will need to make an adjustment when calculating your state income tax. By contrast, Section 179 is allowed by most states and does not require an adjustment.
Under old law, bonus depreciation was 50 percent of the cost of new property and was being phased out over several years ending in 2020. The new law expands the deduction to 100 percent of the property cost from the years 2018-2022. It also allows businesses to elect either the new 100 percent rate or the old 50 percent rate for any property placed into service between Sept. 27, 2017 and Dec. 31, 2017. Starting in 2023, it begins to phase down every 2 years in 20 percent chunks and is eliminated by the year 2028.
Q: Any other corporate tax changes I should know about?
A: Under the new law the deduction for business interest is limited to 30 percent of the company’s taxable income beginning in 2018. Any excess interest that is not deductible in a given year can be carried forward to the next year and potentially taken then, subject to the same 30 percent limitation. Like any good rule, of course, this one comes with exceptions. For the years 2018-2021 taxable income is computed for purposes of this limitation before considering any depreciation and amortization that could normally be taken. This will ease the transition a little by increasing the limits for a few years. Also, the limit does not apply to the following businesses:
§ any business with average gross receipts of less than $25 million over the latest 3-year period
§ any real estate or farming business provided they use a slower depreciation method than is normally allowed
§ public utilities and cooperatives
§ vehicle, boat and machinery dealerships that use floor plan financing
Also new for 2018 is a change to the treatment of business losses. Through 2017, businesses that have a net operating loss (NOL) can either carry the NOL back two years and get a refund of prior year tax paid or elect to carry the NOL forward and apply it against future income without annual limits. So, a loss one year can completely wipe out the income in another year and result in a refund of income tax paid. New for 2018, the carryback option is eliminated so NOLs can only be rolled forward. Also, NOLs can only offset up to 80% of the taxable income in any given year.
Individual Income Tax Changes
Q: How did individual income tax rates change?
A: The new tax law lowered individual rates by both reducing the tax rates charged and expanding the income brackets taxed so less income is taxed at higher rates. Here are the new rates beginning in 2018 and running through 2025:
Married Filing Jointly and Surviving Spouses:
10 percent (Taxable income not over $19,050)
12 percent (Over $19,050 but not over $77,400)
22 percent (Over $77,400 but not over $165,000)
24 percent (Over $165,000 but not over $315,000)
32 percent (Over $315,000 but not over $400,000)
35 percent (Over $400,000 but not over 600,000)
37 percent (over $600,000)
Married Filing Separately:
10 percent (Taxable income not over $9,525)
12 percent (Over $9,525 but not over $38,700)
22 percent (Over $38,700 but not over $82,500)
24 percent (Over $82,500 but not over $157,500)
32 percent (Over $157,500 but not over $200,000)
35 percent (Over $200,000 but not over $300,000)
37 percent (Over $300,000)
Head of Household:
10 percent (Taxable income not over $13,600)
12 percent (Over $13,600 but not over $51,800)
22 percent (Over $51,800 but not over $82,500)
24 percent (Over $82,500 but not over $157,500)
32 percent (Over $157,500 but not over $200,000)
35 percent (Over $200,000 but not over $500,000)
37 percent (Over $500,000)
For a married filing joint return, it takes $29,300 more income to reach the highest tax bracket in 2018 than it did in 2017. Also, the highest rate went down from 39.6 percent to 37 percent for all taxpayers.
Q: Wait, only for years 2018-2025—so these changes aren’t permanent?
No, because of budget rules, Congress was only able to pass the individual tax changes during a limited time frame. So, these new rules only apply through 2025. Without further action by Congress, we will go back to 2017 rules beginning in 2026.
Q: Will I still itemize my deductions next year?
A: That depends on how much your itemized deductions typically amount to each year. The new standard deduction starting in 2018 is $12,000 for single filers and $24,000 for married filing joint. If your itemized deductions are typically less than the appropriate amount for your filing status, then you will be best off taking the standard deduction. These new standard deduction amounts are almost double the old amounts so many taxpayers will no longer be itemizing starting in 2018.
Q: What about personal and dependent exemptions?
A: They are eliminated for tax years 2018-2025.
Q: That doesn’t sound good, will I still get any tax benefit for having children?
A: Yes, the new law increases the child tax credit from $1,000 to $2,000 per child and allows it to be refundable up to $1,400. It also creates a new, nonrefundable $500 credit for qualifying dependents who are not qualifying children. The threshold at which the credit begins to phase out increases from $110,000 to $400,000 for married filing joint returns and from $75,000 to $200,000 for unmarried taxpayers.
Q: I’ve heard that my state income taxes are no longer deductible on my federal tax return—is that true?
A: No, state & local income taxes and property taxes on real estate, vehicles, boats, and RVs are still deductible as itemized deductions, but only up to $10,000 each year. There were discussions early on about eliminating the deduction entirely, but Congress compromised and preserved the deduction with the new cap in place.
Q: What about mortgage interest and charity—still deductible?
A: Yes, they are both still deductible but with changes to their limits. The limit for mortgage interest is reduced but the limit for charity is increased. Old rules allowed mortgage interest to be deducted on up to $1,000,000 of primary loan balance and up to $100,000 of home equity line balance. New law restricts the deduction to only $750,000 of primary loan balance and eliminates any deduction for interest on home equity lines. Charitable deductions used to be limited to 50% of your current year gross income. Now you can deduct contributions up to 60% of your gross income. As in the past, any amount over the limit can be carried forward to be used in a future year, up to 5 years.
Q: And medical deductions?
A: Medical expenses are still deductible, and the new law has enhanced the deduction. Under old law, medical expenses were only deductible to the extent they exceeded 10 percent of your gross income. That threshold is now reduced to 7.5 percent for the years 2017 and 2018. A lower threshold means a bigger potential deduction.
Q: What about miscellaneous deductions such as investment fees, tax prep fees, and unreimbursed employee business expenses?
A: These are no longer deductible starting in 2018
Q: What else has been repealed?
o No more deduction for job-related moving expenses unless you are active duty military moving under orders.
o No more deduction for payments to university booster clubs for the right to purchase athletic tickets (that means Gamecock Club & IPTAY)
o No more alimony deduction for divorce or separation agreements executed after 12/31/18 (new law gives a one-year transition period)
o No more Pease limitation on itemized deductions. This limitation chipped away at the overall amount of deductions allowed for high income taxpayers, taking a bigger chunk at higher income levels.
o The Obamacare individual shared responsibility penalty is reduced to $0, effectively repealing the mandate beginning in 2018.
Q: So, we’re still stuck with death and taxes, right?
A: Right, but at least the IRS will take less of your money when you die. The estate and gift tax exclusion has been doubled to almost $11 million and is indexed for inflation. Like most of the individual changes, the increase only applies for years 2018-2025.
Tony Perricelli, CPA, serves as a member of Scott and Company LLC's tax and advisory practice. He has been providing tax compliance and planning services for closely-held businesses and individuals since he joined the firm in 1998. Tony serves clients in a variety of industries including hospitality, retail, real estate, and professional services. He currently serves on the Board of Directors for the South Carolina Restaurant & Lodging Association and is an active member of the South Carolina Association of Certified Public Accountants and the American Institute of Certified Public Accountants.