The $1.5 trillion new tax law represents the most sweeping change to the tax codes in a generation. Tax reform of this magnitude will have broad implications for businesses of all sizes and in all industries. Below are the top 10 things companies need to know about the tax reform legislation.
Corporate tax rate reduced to 21 percent
The top corporate tax rate was reduced from 35 percent to a flat rate of 21 percent, beginning in 2018. Unlike all other provisions in the new law, including tax breaks for individuals, the new corporate tax rate provision does not expire. Personal service corporations—like healthcare, law, accounting, consulting, financial services, actuarial sciences, performing arts, and athletics—which have historically been subject to some of the highest tax rates—are now taxed at the same rate as other C corporations.
Tax break for owners of pass-through entities
The new law provides owners of pass-through businesses—which include individuals, estates, and trusts—with a deduction of up to 20 percent of their domestic qualified business income (QBI), whether it is attributable to income earned through an S corporation, partnership, sole proprietorship, or disregarded entity. Without the new deduction, taxpayers would pay 2018 taxes on their share of qualified earnings at rates up to 37 percent. With the new 20-percent deduction, the tax rate on such income could be as low as 29.6 percent. However, certain service industries are excluded from the preferential rate, unless taxable income is below $207,500 (for single filers) and $415,000 (for joint filers), under which the benefit of the deduction is phased out.
Potentially large tax benefits by changing company’s entity
Taxpayers should consider evaluating the choice of entity used to operate their businesses. The 21-percent reduced corporate tax rate may increase the popularity of corporations. However, factors such as the new 20-percent deduction for pass-through income, expected use of after-tax cash earnings, and potential exit values will significantly complicate these analyses. The potential after-tax cash benefits ultimately realized by owners could make choice-of-entity determinations one of the most important decision taxpayers will now make.
Significant changes to the international tax system
The United States is moving from its current system of worldwide taxation to a territorial system, under which only domestic earnings are subject to tax. Under the new legislation, some U.S. shareholders of certain foreign corporations will have to pay a one-time “transition tax” on their share of accumulated overseas earnings. Other changes include a “participation exemption,” which is a 100-percent deduction on dividends received by certain U.S. corporations from their foreign subsidiaries. Additionally, some U.S. shareholders of controlled foreign corporations (CFCs) must now include their portion of the “global intangible low-taxed income” of such CFCs as income. There are also new measures to deter base erosion and promote U.S. production.
AMT and DPAD eliminated but Research Tax Credits remain
The law repeals the Section 199 Domestic Production Activities Deduction (DPAD) for tax years beginning after 2017. The Research Tax Credit remains and is now more valuable given the reduction of the corporate tax rate from 35 percent to 21 percent. Beginning in 2018, the corporate Alternative Minimum Tax (AMT) is eliminated. This means taxpayers who would have been subject to AMT and therefore generally would not have been able to use Research Tax Credits to offset their federal income tax liability now will be able to do so. Going forward, any prior corporate AMT credit carryovers may offset the regular tax liability for any taxable year after 2017.
Elimination of NOL carrybacks and limited the use of carryforwards
Previously, businesses were able to offset current taxable income by claiming net operating losses (NOLs), generally eligible for a two-year carryback and 20-year carryforward. Now NOLs for tax years ending after 2017 cannot be carried back, but can be indefinitely carried forward. In addition, NOLs for tax years beginning in 2018 will be subject to an 80-percent limitation. Companies will have to track their NOLs in different buckets and consider cost recovery strategy on depreciable assets in applying the 80-percent limitation.
Accounting methods may change revenue recognition
Under the new law, accrual basis taxpayers must now recognize income no later than the taxable year in which such income is taken into account as revenue in an applicable financial statement. However, new provisions also provide favorable methods of accounting that were not previously available. That, coupled with the reduction in tax rates, creates a favorable and unique environment for filing accounting method changes. There are many method changes still available for the 2017 tax year. Taxpayers should evaluate current accounting methods to identify any actionable opportunities to accelerate deductions and defer income for the 2017 tax year, which could result in significant tax savings.
New rules for bonus depreciation and full expensing on new and used property
The new tax law allows a 100-percent first-year deduction—up from 50 percent—for the adjusted basis of qualifying assets placed in service after September 27, 2017, and before January 1, 2023, with a gradual phase down in subsequent years before sunsetting after 2026. The definition of qualifying property was also expanded to include used property purchased in an arm’s-length transaction. Businesses should pay close attention to any qualifying asset acquisitions made during the fourth quarter of 2017, as the full expensing can be taken on the 2017 return if the property was acquired and placed in service after September 27, 2017. Additionally, under new tax law, taxpayers may now deduct up to $1 million under Section 179 for properties placed in service beginning in 2018 — double the previous allowable amount. The phase-out threshold is increased to $2.5M and will be indexed for inflation in future years and the types of qualifying property have been expanded.
Application of cash method of accounting expanded for small businesses
Beginning in 2018, the average annual gross receipts threshold for businesses to use the cash method increases from $5 million to $25 million. Under the cash method of accounting, companies do not recognize income until actually or constructively received—regardless of whether the purchase, production, or sale of merchandise is an income-producing factor. Additionally, small businesses who meet the $25 million gross receipts threshold are not required to account for inventories and are exempt from the uniform capitalization rules (UNICAP). The $25 million is indexed for inflation for tax years beginning after 2018.
Reassess rewards strategies
Tax reform significantly impacts various components of an employer’s total compensation program including:
- A $1 million deduction cap on pay to the PEO, PFO and top 3 executives for any year
- An excise tax imposed on tax-exempt entities paying over $1 million to their covered employees during a year or providing excessive severance packages to those employees
- Disallowed deductions for transportation fringe benefits provided to employees
- Income inclusion for employer-paid moving expenses
- Further deduction limitations on certain meal and entertainment expenses
- A 2-year tax credit for employer-paid family and medical leave programs
Employer payroll systems must reflect these changes.