The most sweeping tax reform in over 30 years, the Tax Cuts and Jobs Act (TCJA) brings a lot of changes for businesses. If you run a business, you’ve probably been making quarterly payments on your 2018 income tax bill already, but you may not realize the whole scope of the changes until you file your 2018 return at the beginning of next year. To help you prepare, here’s a look at some of the most significant changes.
Lower Corporate Tax Rate
The new tax laws drop the corporate tax rate to 21%. Previously, the tax rate was anywhere from 25% to 38% depending on your corporate tax bracket, and corporations with income between $0 and $50,000 only had to pay 15% in corporate income tax. Theoretically, if your corporation is in that income range, your corporate tax bill may increase. However, hardly any businesses fall in that category. In the past, most corporations paid 35% in federal income tax, and the new rate has the power to save them a lot of money.
Elimination of the Corporate Alternative Minimum Tax
As a bonus, c-corporations no longer have to worry about the alternative minimum tax (AMT). By extension, the cash value in permanent corporate-owned life insurance policies and death benefits are no longer taxable. Under the old rules, these items sometimes ended up being taxed when they were taken into account to calculate corporate AMT.
Wider Availability of Cash-Basis Accounting
In 2017, if your business had over $5 million in gross receipts, you had to use the accrual method of accounting. It was also true if your business stocked inventory to sell and it had over 1 million in gross receipts. Under the TCJA, you don’t have to use the accrual method unless your gross receipts are more than $25 million annually. C-corporations and partnerships with gross receipts under this threshold can opt to use the cash basis of accounting.
Additionally, if you wanted to use the cash method in the past, you had to average sales for every year after 1985. Now, you have to take into account the last three years. The benefit to this shift is that you can defer income. Under the accrual method, you have to account for revenue before you receive it, and as a result, you may end up owing income tax on revenue you haven’t collected. But if you switch to the cash method, you don’t have to report any income until it’s in hand.
New Business Interest Expense Deduction Limits
If your business averages less than $25 million in gross receipts over the last three years, you can deduct all the interest you pay on business loans. If your interest exceeds your profits, you can carry it forward indefinitely. Contrastingly, if your gross receipts exceed $25 million, your business interest deduction is capped at 30% of your adjusted taxable income. Adjusted taxable income is essentially income before interest, tax, depreciation, and amortization. This new rule replaces the old “earnings stripping rules.”
Expanded Section 179 Deductions
Section 179 lets you write off the entirety of some significant business assets in the year of purchase. Usually, if assets don’t qualify for section 179, you have to deduct their value slowly over time. The TCJA increased the deduction limit from $500,000 to $1 million. Also, the phase-out threshold used to start at $2 million, but now, it’s $2.5 million. Both of these limits are indexed for inflation.
The new tax bill also expands the definition of section 179 property. Now, you can apply section 179 to the following:
- Qualified improvements to a building’s interior, except building enlargement, elevators or escalators, and internal structural framework.
- New Roofs
- HVAC Systems
- Fire Protection Systems
- Security Systems
- Alarm Systems
You may also be able to write off a range of other business equipment expenses more quickly. For instance, as of 2018, you can write off most farm machinery in five years instead of seven years. Moreover, you can claim the 100% bonus depreciation on used assets which wasn’t an option in the past.
Indefinite Carry Forward of Net Operating Losses
Unfortunately, you can’t carry operating losses from c-corporations back any longer, but here’s the excellent news — you can now carry these losses forward indefinitely. Previously, you could only carry forward losses for 20 years. Losses from 2018 and beyond can offset up to 80% of your taxable income in future years. Moreover, net operating losses from years before 2018 can offset 100% of your taxable income.
Changes to Meals and Entertainment Deductions
Sadly, those concert tickets, green fees on the golf course, and sporting events are no longer deductible. If you incur entertainment expenses taking clients out, you cannot write off those costs anymore. But, if you take a client to lunch or reimburse an employee for meals while traveling, you can still write off 50% of meals. You can also write off 100% of events that include all of your employees, such as company picnics and holiday parties. Lavish meals are considered entertainment and are not deductible, but “lavish” is open to interpretation. You don’t have to forgo Ruth’s Chris for McDonald’s. Just because you go to an expensive restaurant, hotel, or nightclub doesn’t mean that the expense is lavish. According to the IRS, as long as the expense is “reasonable based on the facts and circumstances,” it’s not lavish.
No Employee Expenses Deduction
In the past, when your employees incurred work expenses were not reimbursed, they could claim a deduction if they itemized and if their expenses were greater than 2% of their adjusted gross income. For instance, they could write off uniforms, home office expenses, and a variety of other costs. This rule is no longer in effect. Although it doesn’t affect your business directly, it impacts your employees, and to offset the potential increase to their income tax liability; you may want to reimburse them for these expenses. Or, you may want to offer a slight boost to their income. Of course, in turn, you can claim a deduction for both of those options. Note that the elimination of the employee expenses deduction does not affect teachers. They have a special $250 deduction for buying school supplies, and they can claim the deduction whether they itemize or not.
New Pass-Through Deduction
The pass-through deduction lets owners of partnerships, S-corporations, and sole proprietorships claim up to 20% of their business income as a deduction on their personal income tax return. The rules are complicated. In some cases, you can only write off 50% of wages paid by your business or 25% of wages and 2.5% of assets. There are also special rules for service-focused firms, and the deduction phases out over a certain income level. Check out this post for a more detailed breakdown of the specifics of the pass-through deduction. These changes have the power to bring a lot of financial tax benefits to businesses. But you need to make sure that you’re making the most of the TCJA. Before the close of 2018, consider consulting with a tax advisor to develop a tax strategy around the new rules.