The Tax Cuts & Jobs Act (TCJA) was signed by President Trump on December 22, 2017 and is touted as the most sweeping tax reform in over three decades. The changes provide some great opportunities and incentives for contractors to invest in their businesses and employees, including saving on taxes!
Impacting everything from cradle (child tax credits and personal exemptions) to grave (estate/gift tax exclusion), this comprehensive legislation changes income tax rates, brackets, eligible accounting methods, deductions, and more. Knowing just how the TCJA will affect you and your company can help you begin planning for how to take advantage of these changes.
Businesses
Perhaps the most widely publicized change in the tax law is the reduction in the income tax rate for C Corporations. C Corps, or companies that pay income tax at the corporate level. These companies will see their income tax rates plummet from a maximum of 35% in 2017 to the new flat rate of 21% effective 1/1/2018.
For individuals who own pass-through entities (S Corps, LLCs, Sole Proprietorships), a new deduction was created for up to 20% of their pass-through income, though subject to certain limitations. Those limitations also can be very complex and fairly restrictive, making the deduction less attractive than what many people may have heard. In fact, the deduction itself phases out for professional service businesses (healthcare, legal, accounting, etc.) between $315,000 and $415,000 of married filing jointly (MJF) taxable income. But these two changes combined — the new 21% C Corp income tax rate and the limited deduction of pass-through income for S Corp owners — now puts the C v. S Corp entity decision back into play.
Another major change for both C and S Corporations is that if they have < $25 million in average annual gross receipts, they can use the cash method of accounting for federal income tax purposes. That threshold had been $5 million for C Corps, $10 million for S Corp contractors, and companies with inventory could not use it. The new law makes it available to more small companies, including those with inventory.
In addition, since Alternative Minimum Tax (AMT) is repealed for C Corps, the cash method of accounting may be the best TCJA tax saving opportunity for small C corp businesses.
For example, let’s say a contractor has $2 million in Accounts Receivable and $800,000 in Accounts Payable. Using the cash method, that contractor can defer paying income tax on the $1.2 million difference between A/R and A/P until his business has > $25 million in 3-year average annual gross receipts.
Unfavorable changes for businesses also pepper the TCJA. Some of those include:
- A new net business interest expense deduction limitation of 30% of adjusted taxable income
- The elimination of:
- Like-Kind Exchanges (LKEs) on personal property such as autos, equipment, and furniture (LKEs are retained for real property)
- Section 199 Domestic Production Activities Deduction (was 9% of eligible Revenue for some contractors, now 0% in 2018)
- Entertainment expenses (though business meals will still be 50% deductible), and
- Net Operating Loss (NOL) carry-backs. NOLs will now carry-forward indefinitely, but can offset only up to 80% of taxable income in a single year
On the plus side:
- Research and Development (R&D), Work Opportunity, and Low Income Housing tax credits have been retained, and
- A new Family & Medical Leave Act (FMLA) tax credit for up to 25% of FMLA wages paid voluntarily (not required by state or local governments) is now available
Among the most important, yet unheralded, elements of the TCJA for both businesses and individuals are the changes to depreciation. Annual Section 179 expense on the purchase of fixed assets has risen from $510,000 to $1 million, with the phase out threshold rising from $2.03 to $2.5 million for total assets purchased. In addition, property eligible for Section 179 expensing now includes improvements to roofs, HVAC, security systems, and fire protection and alarm systems.
But perhaps the biggest business incentive (although one for which most ACI companies will probably not buy enough equipment to use) is the change in bonus depreciation. Previously allowed up to only 50% of new equipment, companies can now take bonus depreciation on 100% of the cost of new and used equipment — with no limit — through 2022. This, coupled with the new 21% flat C Corp tax rate, will now make investing in the USA more attractive. Look to see big businesses buy more equipment and expand their U.S. operations.
Individuals
If the new depreciation rules are the least known benefit of TCJA, certain changes for individuals are among of the best known. Individual income tax rates have fallen, and brackets for those new, lower rates have widened (see Table 1). Simply put, that means more of our personal income will be taxed at the lower rates, so most people will experience a tax savings and increased disposable income.
The child tax credit doubled from $1,000 to $2,000 for children under 17, and the phase-out threshold for taking that credit jumped from $110,000 to $400,000 for MFJ. The AMT exemption threshold also increased from $86,200 to $109,400, and the phase-out threshold for using that exemption rose from $164,900 to $1 million (MFJ). As such, far fewer households will be subject to AMT. On top of that, AMT credits accumulated through 2017 carry-forward and are refundable when the taxpayer is not subject to AMT through 2021.
Tax Simplification?
Initially promoted as “Tax Simplification,” the final version of the TCJA is anything but simple. It will, no doubt, once again earn the nickname of “The Accountants and Lawyers Full-Employment Act.”
But some changes for individuals were enacted to make both figuring and filing your personal income taxes easier.
Provisions beneficial to individuals include:
- Increase in the Standard deduction from $12,700 to $24,000 (MFJ)
- Charitable contributions deduction limit increase from 50% to 60% of Adjusted Gross Income (AGI)
- Repeal of the phase-out of itemized deductions for high-income taxpayers (was > $313,000 in 2017 for MFJ)
- Doubling of the Estate/Gift Tax Lifetime Exclusion to $11.2 million/person
- Increase in the annual gift tax exclusion from $14,000 to $15,000
- Step-up in basis for inherited assets was retained
Some of those provisions which negatively impact individual taxpayers include:
- Repeal of
- Personal exemptions (was $4,050/person)
- Miscellaneous itemized deductions (tax preparation fees, investment advisor fees, etc.)
- Moving expense deduction
- Alimony (for divorce decrees entered into after 12/31/18)
- Charitable donations made for the right to purchase athletic tickets
- Home equity line of credit interest
- New limitations for
- State and local tax deduction ($10,000)
- Mortgage interest deduction – Eligible acquisition indebtedness reduced from $1 million in debt to $750,000, but loans in place as of 12/31/17 are grandfathered in
Time to decide!
While the TCJA offers both opportunities and incentives to businesses and their owners, deciding which ones — and when to take advantage of them — may not be easy. If your company is an S Corp now, should you elect C Corp status to get the 21% flat tax rate? If not, then how much should an S Corp owner take in wages vs. pass-through income to maximize his 20% pass-through income deduction? And if your business has < $25 million in average annual gross receipts, should you elect to be a cash-basis taxpayer?
These are just some of the questions small business owners will need to answer about how to proceed in 2018, but they cannot be answered in a vacuum. Consult your CPA — the right choice for one business or individual may not work for another. At VonLehman, we can help you decide which path is best for you.
