The Tax Cuts and Jobs Act (H.R. 1, “TCJA”) has been enacted into law. The bill contains many provisions affecting both individuals and businesses. The main provisions affecting businesses are summarized below. Except where otherwise noted, all of these changes take effect January 1, 2018.
The cornerstone of the TCJA is a new lower 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 single flat tax rate of 21%. This replaces the tax rates ranging from 15% to 35% that C corporations paid under prior law.
The vast majority of smaller businesses are not organized as C corporations. Instead, they are pass-through entities. This includes 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 now 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 now may be eligible to deduct an amount up to 20% of their net business income. This 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. Thus, 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 on Jan. 1, 2026. This complex deduction works as follows:
A pass-through owner qualifies for an income tax deduction equal to 20% of net pass-through income if he or she:
This deduction is phased out if income exceeds the $315,000/$157,500 limits. It disappears entirely for marrieds filing jointly whose income exceeds $415,000 and for singles whose income exceeds $207,500.
If a pass-through owner’s annual taxable income from all sources after deductions is over $415,000 if married filing jointly, or $207,500 if single, he or she is still entitled to a pass-through deduction of up to 20% of net business income. However, the deduction cannot exceed:
Since 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.
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 $315,000 if married filing jointly, or $157,500 if single. The deduction is phased out if income exceeds the $315,000/$157,500 limits. It disappears entirely for marrieds filing jointly whose income exceeds $415,000 and for singles whose income exceeds $207,500. 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.
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. Prior to 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 increases the bonus depreciation amount to 100%. The increase goes 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:
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 removes them from this classification starting in 2018. Thus, bonus depreciation may be used to deduct computers used less than 50% of the time for business.
There are annual limits on the amount of depreciation that can be taken on passenger automobiles used for business. The TCJA increased these limits to $10,000 for the first year the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years.
Under prior law, a provision of the tax law called Section 179 allowed business owners to deduct in a single year up to $510,000 of the cost of personal property they purchased and used for their business over 50% of the time. The TCJA increases this amount to $1 million. The $1,000,000 amount is reduced (but not below zero) by the amount by which the cost of property placed in service during the year exceeds $2,500,000.
Larger businesses—those with average gross receipts of $25 million or more—would not be allowed to deduct interest payments in excess of 30% of their taxable income. Any interest amounts disallowed under this provision would 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 continue to deduct all their interest payments.
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 eliminates carrybacks of NOLs—that is, they may only be deducted in current and future years. Additionally, taxpayers are allowed to deduct NOLs only up to 80% of taxable income. Unused NOL amounts may be carried forward and deducted in any number of future years.
The new law also eliminates various business tax deductions and credits, including the: