By Cathleen D. Wyatt, Attorney with Frost Brown Todd LLC
The Tax Cuts and Jobs Act (TCJA) was signed into law on December 22, 2017, and has made a number of changes that business owners need to have on their radars. Here’s a short list of important changes that business owners should be aware of:
1. Tax Rate Changed to a Flat Rate of 21% for Corporations
Under prior law, a corporation’s taxable income was subject to tax under a graduated rate structure with a top corporate tax rate of 35%. As of January 1, 2018, all corporations will pay a flat tax rate of 21%. This change may cause some business owners to revisit their choice of entity, since the double taxation problems related to corporations (i.e. tax on corporate income and tax on dividends to shareholders) have been somewhat mitigated.
2. New Qualified Business Income Deduction
This is a new deduction that is only for “pass-through” entities, such as LLCs that are treated as partnerships for tax purposes, S corporations and partnerships. Under prior law, taxable income that “passed through” one of these entities to an individual owner was taxed at the individual’s income tax rate (with a top marginal tax rate of 39.6%) and not subject to tax at the entity level.
Effective after December 31, 2017 and before January 1, 2026, an individual taxpayer generally may deduct 20% of “qualified business income” (QBI) from a partnership, LLC, S corporation or sole proprietorship, subject to limitation at higher income levels. Thus, unlike the reduced tax rate for corporations, the QBI deduction sunsets unless Congress passes legislation to extend the deduction. Generally, the QBI deduction is available to all taxpayers with taxable income (from all sources) below $315,000 (married filing jointly) or $157,500 (for other filing types). However, if a taxpayer’s taxable income exceeds those threshold amounts, the taxpayer’s ability to use the QBI deduction could be subject to two limitations that are phased-in over a range of $100,000 (married filing jointly) or $50,000 (for other filing types).
First, where the taxpayer’s taxable income exceeds the fully phased-in income threshold, the QBI deduction is limited to the greater of 50% of the taxpayer’s share of wages paid with respect to their qualified business (W-2 Wages), OR 25% of the W-2 Wages plus 2.5% of the taxpayer’s share of the cost of any tangible depreciable property used in the qualified business.
Second, where the taxpayer’s taxable income exceeds the phased-in threshold, the QBI deduction does not apply to income from a “specified service business.” Specified service businesses include any trade or business involving the performance of services in the fields of health, law, accounting, consulting, athletics, financial services or brokerage services, or any trade or business where the principal asset of the business is the reputation or skill of one or more employees or owner(s). Other limitations apply, but the QBI deduction may be a significant tax break for those businesses and individuals who qualify.
3. Increased Bonus Depreciation
Under prior law, taxpayers generally were required to capitalize the cost of property used in a trade or business or held for the production of income and recover cost over time through annual deductions for depreciation or amortization. There was also an additional first-year bonus depreciation deduction allowed that was equal to 50% of the adjusted basis of qualified property acquired and placed in service before January 1, 2020.
The TCJA extended and modified the first-year bonus depreciation deduction through 2026 (through 2027 for longer production period property and certain aircraft). The 50% allowance is increased to 100% for property placed in service after September 27, 2017, and before January 1, 2023. The 100% allowance is phased down by 20% per calendar year for property placed in service in taxable years beginning after 2022. Significantly, the TCJA also expands qualified property to include used property, and allows additional first-year depreciation deductions for used property.
One concern with the bonus depreciation is that each state can elect to conform to certain tax provisions. Where new federal tax legislation could lead to a loss of tax revenue for the state, states may choose to refuse to conform to the new federal provisions. Some states did not elect to conform with previous bonus depreciation provisions, and may elect not to do so now. Taxpayers should not assume that they will be entitled to similar enhanced depreciation at the state level.
This brief discussion was intended to provide a high level look at some of the big tax changes that will impact your businesses in 2018 and beyond. However, we’ve only scratched the surface, and you will need to take the next step by contacting your trusted tax, accounting and legal advisors to determine how these changes, and others that were not discussed, will impact you and your businesses going forward. Working with your tax advisor to understand the new tax legislation and stay on top of any new guidance, will help you plan to keep your business operating in the most tax efficient manner.
This material has been prepared for informational purposes only, and is not intended to provide tax, legal or accounting advice. You should consult your own tax, accounting and legal advisors for more information and advice tailored to your specific business.