Last week, we discussed the individual provisions of the Tax Cuts and Jobs Act of 2017, which was signed by President Trump on December 22, 2017. This week we are going to cover the business provisions of the act which may affect you as business owner or investor. Like the individual provisions, most all of the business provisions took effect on January 1, 2018, and many are only temporary and expire in 2025. As we stated last week, the new act was business focused and implemented three major business tax policy shifts: 1) reduce corporate tax rates, 2) shift from worldwide business taxation to a territorial system, and 3) shift from depreciation to capital asset expensing. In addition, there were numerous other changes affecting businesses. Here’s a look at some of the key business provisions of the new law that may affect you as a business owner or investor.
Tax rates. One of the most sweeping changes in the tax law since the Tax Reform Act of 1986 is the elimination of all corporate tax rate brackets and implementation of a flat tax of 21% on C-corporations, which are not pass-through S-corporations. If your corporate income is below $75,000, you will see a tax increase as a result of the change to 21% from 15% or 25%. If your corporate income is more than $75,000, your income tax is reduced as a result of the rate decrease to 21% from 34% to 39%. Although many of the provisions of the new act expire after 2025, this provision is made “permanent”, unless of course, the folks in Washington change it.
Before the act passed, the U.S. had the highest overall corporate income tax rate among the Organisation for Economic Co-operation and Development (OECD) member nations at 38.9% (35% federal plus the 3.9% average state corporate income tax rate). This was some 15% higher than the OECD member nation average without the United States of 23.8%. Under the new act, the U.S. overall rate dropped from 38.9% to 25.7%, slightly above the OECD member nation average of 23.8%. This arguably makes the U.S. more competitive in the world business market.
Capital gains. Although the new law reduced the preferential tax rates on long-term capital gains for individuals and pass-through entities, such as S-corporations, sole proprietorships and partnerships, capital gains of C-corporations receive no special treatment. However, C-corporation capital gains are taxed at the new corporate ordinary income tax rate of 21%.
Dividend received deduction reduced. Under the prior law, a C-corporation could exclude from income 70% of dividends received from a less than 20% owned corporation and exclude 80% of dividends received from a more than 20% owned corporation. The new law reduces the 70% to 50% and the 80% to 65%. The effect of this is to basically keep the tax on corporate dividends the same under the new act as was previously under the old act. The reduced rate on the increase in income is pretty much a wash in most instances.
Changes on the taxation of foreign income. These provisions will effect few small businesses, but they have a huge effect on multinational corporations. There are three main components. Firstly, dividends from foreign affiliates receive a 100% deduction, whereas they were previously taxed a 35% with a credit for foreign taxes paid. Secondly, foreign affiliate income is now currently taxed at 10.5% with a credit for 80% of foreign taxes paid, whereas under the old system, they were not taxed until the income came to the U.S. Lastly, there is a one-time tax of 8%-15% on past foreign profits with a credit for foreign taxes paid and which is payable over 8 years, whereas under the old system, they were not taxed until the income came to the U.S. Contrary to claims by supporters of the act, this does not look to me to be a shift from worldwide business taxation to a territorial system.
Capital asset expensing. The $510,000 maximum Section 179 deduction with a phase-out beginning at $2.03 million for leasehold improvements, equipment, furniture, and other tangible personal property has been expanded. Under the new act, the maximum deduction is increased to $1 million with a phase-out beginning at $2.5 million, both indexed to inflation. In addition, the assets deductible now include tangible personal property used to provide lodging and an expanded list of qualified real estate, such as roofs and HVAC equipment.
The Section 168(k) bonus depreciation has been temporarily increased to 100% through 2022 and has been expanded to include used property and certain property used in film, TV and theater productions. This temporary increase will be then phased-out 2023-2027.
Alternative Minimum Tax relief. The new law “permanently” eliminates the alternative minimum tax for C-corporations.
Business meals and entertainment. The new act eliminates the deduction for most all entertainment expenses. No deduction is allowed for any entertainment, amusement or recreation activities and any membership dues in any club organized for business, pleasure, recreation or other social purposes. Professional dues and trade or business association dues continue to be deductible. There are also 9 specific exceptions to the prohibition on the deductibility of entertainment expenses. Travel business meals continue to be 50% deductible, but the new law was not clear whether other business meals continue to be 50% deductible. Most of the commentators which I have read conclude that all business meals continue to be 50% deductible.
Pass-through income deduction. There is a new 20% deduction on your U.S. 1040 individual income tax return for business income from pass-through entities such as S-corporations, sole proprietorships and partnerships. The deduction generally does not apply to investment or wage income. If your income exceeds $157,500 single or $315,000 joint, your deduction may be limited based upon either: 1) the W-2 wages paid and depreciable assets of the entity, and/or 2) if the income was earned from certain personal service businesses, such as health, law, accounting, athletics, performing arts, or any other business where the principal asset is the reputation or skill of one or more employees. This deduction only applies to the income tax, not the self-employment tax.
To find out how this will affect you, run the numbers. Do a calculation or have your tax preparer do a calculation using the 2018 rules with your 2017 income and deductions and compare your tax liability. The new tax act may have helped your business, or it may not have.
By Matthew M. Wallace, CPA, JD
Published edited June 17, 2018 in The Times Herald newspaper Port Huron, Michigan as: Business provisions of the new tax bill