How the Tax Cuts and Jobs Act Affects Businesses

In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA), the most significant tax reform law in over 30 years. The TCJA continues to have a big impact on businesses' taxes. Except where otherwise noted, all of the changes covered in this article took effect January 1, 2018, and are scheduled to expire December 31, 2025.

Flat Corporate Tax Rate

The cornerstone of the TCJA is a lower income tax rate for regular C corporations. C corporations are separate taxpaying entities with their own tax rates. Under the TCJA, all C corporations are subject to a single flat tax rate of 21%. This flat rate replaces the tax rates ranging from 15% to 35% that C corporations paid under prior law. Unlike most of the other changes made by the TCJA, the 21% corporate tax rate is permanent.

Pass-Through Tax Deduction

The vast majority of smaller businesses are not organized as C corporations. Instead, they're pass-through entities, including sole proprietorships, limited liability companies, partnerships, and S corporations. These entities pay no taxes themselves. Instead, the profits from these businesses are passed through the entity, and the owners pay tax on them at their individual tax rates. These rates are higher than the 21% rate for C corporations—under the TCJA, the top individual tax rate is 37%.

The TCJA created a new tax deduction for people who earn income through pass-through entities. (New IRC Sec. 199A.) These individuals might be eligible to deduct an amount up to 20% of their net business income. This deduction is in addition to all their other business deductions. If this deduction applies, a pass-through owner is effectively taxed on only 80% of business income. So, the effective rate for pass-through owners in the top 37% tax bracket is 29.5%.

This is a personal deduction pass-through that owners can take on their returns whether or not they itemize. This deduction is scheduled to end in 2026. All the amounts shown below are subject to annual adjustments—these are the amounts for 2022. The deduction works as follows:

2022 Income Below $340,100 ($170,050 for Singles)

A pass-through owner qualifies for an income tax deduction equal to 20% of net pass-through income if that person:

• operates the business as a sole proprietor, LLC owner, partner in a partnership, or S corporation shareholder, and
• total taxable income for the year from all sources after deductions is below $340,100 if married filing jointly, or $170,050 if single (2022).

This deduction is phased out if income exceeds the $340,100/$170,050 limits. It disappears entirely for marrieds filing jointly whose income exceeds $440,100 and for singles whose income exceeds $220,050.

2022 Income Above $440,100 ($220,050 for Singles)

If a pass-through owner's annual taxable income from all sources after deductions is over $440,100 if married filing jointly, or $22,050 if single, the owner is still entitled to a pass-through deduction of up to 20% of net business income. But the deduction can't exceed:

• 50% of the owner's applicable share of the W-2 employee wages paid by the business, or
• 25% of the owner's share of the W-2 wages paid by the business, plus 2.5% of the original purchase price of the long-term property used in the production of income—for example, the real property or equipment used in the business.

Because many owners of pass-through businesses have no employees, the 25% plus 2.5% deduction will be of most benefit to them. The 2.5% deduction can be taken during the entire depreciation period for the property. However, it can be no shorter than 10 years.

No Pass-Through Deduction for Service Business Owners

Special rules apply to pass-through owners whose business involves providing various services including health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing and investment management, trading and dealing in securities or commodities, or any business where the principal asset is the reputation or skill of one or more of its owners.

These service business owners are entitled to the 20% pass-through deduction only if their taxable income from all sources after deductions is less than $340,100 if married filing jointly, or $170,050 if single. The deduction is phased out if income exceeds the $340,100/$170,050 limits. It disappears entirely for marrieds filing jointly whose income exceeds $440,100 and for singles whose income exceeds $220,050. Service pass-through owners whose income exceeds the thresholds are not entitled to the 50% of W2 employee or 25% of W2 employee plus 2.5% of business property deduction.

100% Bonus Depreciation

"Bonus depreciation" allows a business owner to deduct a substantial amount of a long-term asset's cost in a single year instead of depreciating the cost over many years. Before the enactment of the TCJA, the bonus depreciation amount was 50%—that is, 50% of the cost of an asset could be deducted in the first year, with the remaining cost deducted over several years. The TCJA increased the bonus depreciation amount to 100%. The increase went into effect for long-term assets placed in service after September 27, 2017. In addition, for the first time, bonus depreciation may be used for purchases of used as well as new property.

The 100% amount is scheduled to remain in effect until January 1, 2023. In later years, the first-year bonus depreciation deduction amount goes down, as follows:

• 80% for property placed in service after December 31, 2022 and before January 1, 2024.
• 60% for property placed in service after December 31, 2023 and before January 1, 2025.
• 40% for property placed in service after December 31, 2024 and before January 1, 2026.
• 20% for property placed in service after December 31, 2025 and before January 1, 2027.

Listed property must be used over 50% of the time for business to qualify for bonus depreciation. Computers were classified as listed property under prior law, but the TCJA removed them from this classification. So, bonus depreciation may be used to deduct computers used less than 50% of the time for business.

Automobile Depreciation Limits

Annual limits apply to the amount of depreciation that can be taken on passenger automobiles used for business. The TCJA increased these limits, which are adjusted each year for inflation. For automobiles placed in service in 2021, depreciation is limited to $10,200 for the first year the vehicle is placed in service, $16,400 for the second year, $9,800 for the third year, and $5,860 for the fourth and later years (subject to annual adjustments). If first-year bonus depreciation is claimed, the first-year limit is increased by $8,000 to $18,200.

$1 Million Section 179 Expensing

A provision of the tax law called "Section 179" allowed business owners to deduct in a single year up to the cost of personal property they purchased and used for their business over 50% of the time. An annual limit applies to this deduction. The TCJA increases the limit to $1 million, adjusted for inflation each year. For 2022, the limit is $1,080,000. The $1,080,000 amount is reduced (but not below zero) by the amount by which the cost of property placed in service during the year exceeds $2,700,000.

Limits on Deducting Business Interest

Larger businesses—those with average gross receipts of $25 million or more—aren't allowed to deduct interest payments in excess of 30% of their taxable income (50% for 2019 and 2020). Any interest amounts disallowed under this provision must be carried forward to the succeeding five taxable years. Businesses with gross receipts less than $25 million are not subject to this restriction and may deduct all their interest payments each year. Real property businesses with more than $25 million in gross receipts may elect out of the 30% limitation by agreeing to depreciate their real property over a somewhat longer period.

Limits on Deducting Net Operating Losses

A business has a net operating loss (NOL) if its expenses exceed its income for the year. Under prior law, if a business had an NOL, it could be carried back two years, resulting in a refund of all or part of the taxes paid in those years. The TCJA eliminated all carrybacks of NOLs starting in 2018. Instead, taxpayers were only allowed to deduct them in any number of future years. Moreover, an NOL could only offset up to 80% of taxable income (before the pass-through deduction) for any year.

But due to the economic devastation caused by the coronavirus (COVID-19) pandemic, Congress amended the rules for 2018 through 2020. For these years, an NOL may be carried back five years and then carried forward indefinitely until used up. Also, NOLs for these years may offset 100% of taxable income to reduce the tax liability to zero.

The NOL rules that the TCJA initially put in place in 2018, and then postponed for 2018-2020, returned for 2021 and later. So, for 2021 and later years you may only deduct NOLs for the current year and any number of future years. You may not carry them back to deduct in past years. In addition, NOLs for these years may only offset up to 80% of taxable income (before the pass-through deduction) for any year.

Elimination of Certain Deductions and Credits

The TCJA also eliminated various business tax deductions and credits, including:

• the deduction for business entertainment expenses, except for meals
• starting in 2026, the deduction for meals provided to employees for the convenience of the employer
• the deduction for payment of employee parking, mass transit, or commuting expenses
• the domestic production activities deduction, and
• the deduction for local lobbying expenses.