The landmark passage of the Tax Cuts and Jobs Act (TCJA) in late 2017 brought the most significant changes to the tax landscape we have seen since 1986. Now that we are fully immersed in the first full tax season under the new law, many businesses could have significant adjustments to make for filing season and for the year ahead.
One area particularly affected by the TCJA was how corporations and business entities choose to classify themselves, namely as either C Corporations (with profits taxed separately from the company’s owners) or S Corporations (pass-through entities). With the TCJA, a much lower, corporate tax rate of 21% took effect—down from 35%—which had a direct and very positive impact on C Corporations, and left many S Corporation owners considering changing to C Corporation status to take advantage of such a significant reduction.
But that cannot be the only factor in considering whether to change. For example, does the business qualify for the new 20% Qualified Business Income (QBI) deduction? Is the business owner aware of the risk that C Corporation owners could pay two layers of taxes, namely if they are paying wages or paying dividend distributions to themselves? Owners should also be mindful of whether they plan to sell the business in the next few years; if that is the case it could make sense to remain a pass-through entity.
There is also the question of whether the business has or will incur losses. Owners need to take note that in a C Corporation, those losses stay within the business, whereas with an S Corporation the losses could be used to offset other personal income. With C Corporations, no such benefit exists. Again, restructuring the corporate classification is not always the easiest decision; all relevant facts and circumstances should be carefully weighed in order to make the appropriate decision.
When the TCJA passed, significant deductions were expanded for asset acquisitions through both bonus depreciation as well as depreciation deductions through Section 179 of the IRS Tax Code. Bonus depreciation for property acquired and placed in service in 2018 is equal to 100% of the cost of the eligible property. The original use of the property must begin with the taxpayer; however, used property acquired by the taxpayer is also now eligible for bonus depreciation. Prior to TCJA, bonus depreciation was limited to 50% of the cost, which then phased down even further in subsequent years. Under the new law, the 100% deduction will phase down ratably to 20% in the year 2026. There are strict rules in place defining “eligible property,” so taking advantage of these favorable rules should be done carefully.
In addition to favorable bonus depreciation rules, businesses also have the option of immediately expensing the cost of certain eligible property under Section 179. The maximum amount that can be expensed under this section is $1 million; however, please note this threshold is subject to other limitations. Also note that some states have decided to “opt out” of allowing Sec. 179 expensing and bonus depreciation. As a result, businesses might find themselves with a favorable federal deduction but not so much for state tax purposes.
Under the TCJA, businesses are no longer automatically able to deduct certain employee benefits and various other expenses to minimize their tax liability. A number of important employee benefits have now been either eliminated or reduced, including moving expenses, transportation costs, on-site meals and employee awards. There are also new rules governing the treatment and deductibility of certain parking costs or benefits.
Alternatively, the TCJA does provide for a new tax credit in 2018 and 2019 for an applicable percentage of the wages paid to qualifying employees for family and medical leave under the Family and Medical Leave ACT (FMLA). The applicable percentage is 12.5% of the wages paid during the leave period if the amount paid to the employee is at least 50% of the wages normally paid. This percentage can increase up to a maximum credit of 25%. The credit is determined based on the employee’s normal hourly wage rate; however, if the employee is not paid hourly their wages are prorated to an hourly rate accordingly.
Finally, there is the question of what comes next with tax policy. With the ever-changing political landscape, there is much uncertainty both short and long-term. For now, the prudent approach is to carefully consider the broad net of favorable and unfavorable new tax laws to ensure you are well informed and poised to be in the best possible tax position. This summary is just the tip of the iceberg in terms of the sweeping new tax laws; however, the intent is to shed light on the significant impact just one change might have on your current or future tax liability or business structure. Taking the time to consider the impact the TCJA might have on your business will not only ensure you’re making smart decisions—doing so could very well lead to meaningful tax savings and opportunities.
Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.