In the Tax Cuts and Jobs Act of 2017 (Tax Act), changes to business taxation are considerable and comprehensive. Because many of our clients are structured as pass-through entities and small businesses, we wanted to address several of the most significant changes for 2018 tax planning and reporting here.
Effective in 2018, business income that passes through to an individual from a pass-through entity and income attributable to a sole proprietorship will be taxed at individual tax rates — less a deduction of up to 20% to bring the rate lower.
How does this apply to your business entity structure? If your personal taxable income is below the threshold amount, the deductible amount for each of your businesses is 20% of your Qualified Business Income (QBI) with respect to each business. The threshold amount is $157,500 for individual taxpayers and $315,000 for married taxpayers filing jointly. Phase-ins apply, which means that the benefit decreases as income increases.
If your taxable income is above the threshold amount, you are subject to limitations and exceptions, which are determined by your occupation and a wage (and capital) limit.
If you own a specified service business and your taxable income exceeds the threshold amount plus the phase-in range ($207,500 for individual taxpayers and $415,000 for married taxpayers filing jointly), then you lose the deduction completely. In that case, you pay tax using your individual tax rate.
For all other businesses, if your taxable income exceeds the threshold amount, then the wage (and capital) limit kicks in. The wage (and capital) limit formula is: the greater of 50% of W-2 wages with respect to your trade or business, including shareholder wages, or the sum of 25% of W-2 wages + 2.5% of the unadjusted basis, immediately after acquisition, of all qualified property. The addition of qualified property to the formula accommodates businesses that rely on the acquisition of capital, like real estate businesses.
If you sell qualified property before year-end, it’s no longer available for use and is not used in the formula. It’s not yet clear under the law what will happen in circumstances such as like-kind exchanges or involuntary conversions. We will keep you posted on those IRS updates as they happen.
Now, after the calculation if the net amount of your QBI is a loss, you may carry it forward as a loss to the next tax year. Keep in mind that these deductions from income reduce your taxable income on your individual return. It doesn’t change how you calculate your taxable income inside your business. Business expenses remain deductible.
Additional rules apply to qualified cooperative dividends, qualified REIT dividends, and qualified publicly traded partnership income, so it’s important to address these circumstances in your business or investments. If you hold foreign interests or receive income from such entities, this is a whole other area of consideration that we can review for you.
The new tax law now provides for a flat 21% tax rate for corporations rather than a progressive tax as in years past. This is a huge change, in that previous progressive corporate tax rates ranged from 15% to 39% (except for personal service corporations which are taxed at 35%).
Business deductions for meal and entertainment expenses are in for some changes. Deductions for expenses when entertaining clients and deductions for meals provided for the convenience of the employer are being reduced and even eliminated. Specifically, ticket expenses for clients at events, including charitable events, will no longer be deductible for 2018. Deductions for meals provided for the convenience of the employer will go from 100% deductible to 50% deductible and then phase out completely in 2025.
Effective for tax years beginning after December 31, 2017, taxpayers in entities with annual average gross receipts that do not exceed $25 million for the three prior tax years are allowed to use the cash method of accounting rather than the accrual method. The gross receipts threshold was raised for all affected entities. Exemptions for qualified personal service corporations, partnerships, S Corporations and other pass-through entities are retained. They can use the cash method without regard to the gross receipts threshold as long as the use of the method clearly reflects income.
Another change that we think will be especially helpful for business owners is that first-year bonus depreciation is now 100 percent and it applies to both new and used property. It is available for certain business expenses including machinery and equipment and qualified improvement property acquired and placed in service after September 27, 2017. The 100% expensing is available through 2022, after which it begins phasing out by 20% per year until it is fully phased out in 2027.
In addition, the Tax Law has adjusted popular Section 179 expensing by increasing the deduction of tangible personal property from $500,000 to $1 million. The phase-out limitation increases from $2 million to $2.5 million for tax years beginning after December 31, 2017. The new law increases the scope of qualified property to include “qualified real property,” which includes certain improvements to nonresidential real property.
Let’s also briefly address changes for individuals in 2018, whether you own a business or not. First, it will be important to identify your new federal tax rate, which in general may be significantly lower. Here are the revised individual federal tax rates for the 2018 tax year:
Married Filing Jointly
Up to $9,525
Up to $19,050
$9,526 to $38,700
$19,051 to $77,400
38,701 to $82,500
$77,401 to $165,000
$82,501 to $157,500
$165,001 to $315,000
$157,501 to $200,000
$315,001 to $400,000
$200,001 to $500,000
$400,001 to $600,000
Note: These rates are scheduled to expire on or after January 1, 2026 unless Congress extends them.
The standard deduction in 2017 is $13,000 for a couple filing jointly. That number jumps to $24,000 in 2018. For single filers, it increases from $6,500 to $12,000. You may take a standard deduction rather than itemizing deductions due to this increase if your itemized deductions fall below this revised amount for 2018.
Several key changes are coming for taxpayers who itemize deductions. State and local taxes can still be itemized, but they are now capped at $10,000. Interest on mortgages for primary and secondary residences is still deductible. The limit, however, has come down from loans up to $1 million to loans up to $750,000. Another big change is the loss of a deduction for interest paid on home equity lines of credit (HELOC) as of 2018 and moving forward.
People who use their home equity lines to help pay for college, for example, may have to refigure their payment arrangements, since they will no longer be able to deduct the interest charged on HELOCs.
Generally, all miscellaneous deductions, moving expenses, alimony payments and personal casualty losses (except from federally declared disasters) are being repealed as deductible expenses.
Medical expenses in 2017 and 2018 remain deductible to the extent they exceed 7.5% of income (down from 10%).
The child tax credit has doubled for eligible taxpayers from $1,000 per child to $2,000 per child starting on or after January 1, 2018, with $1,400 per child deemed refundable. If your child was born on January 1, 2018, the credit applies. However, the credit ends once your child turns 17 anytime within the tax year. To offset the elimination of all dependent exemptions beginning in 2018, a new $500 “family credit” per eligible dependent applies to households that claim adult dependents (elderly parents or college students who do not claim themselves on a personal tax return, for example).
Depending on their taxable income, fewer households may be at the AMT threshold due to raising AMT income exemption levels for the 2018 tax year. The increased income exemption levels are $70,300 for singles, up from $54,300 in 2017; and to $109,400, up from $84,500 in 2017, for married couples filing jointly or surviving spouses. There is also a new income phase-out level, at $500,000 for single filers and $1 million for married filing jointly filers or surviving spouses. The limitation in state and local tax deductions, which has been a typically large AMT add-back, and the other changes found the Tax Law will essentially eliminate AMT for most taxpayers.
Charitable deduction rules remain relatively untouched, but the Tax Act increases the level of charitable contributions allowed while requiring individuals to have more written proof for larger donations. It increases the percentage limit for charitable contributions of cash to public charities from 50% to 60% of an individual’s adjusted gross income. It permanently denies a charitable deduction for payments made in exchange for college athletic event seating rights, and there is a permanent repeal to the exception of contemporaneous written acknowledgment for contributions of $250 or more based on a properly filed charitable organization tax return. In other words, get the proof in writing for your large donations.
The Tax Act does not repeal the estate, gift or generation-skipping transfer taxes at any point, as many were lobbying for. However, from 2018 through 2025, the estate and gift tax unified exemption will be $10 million (instead of the current $5 million), adjusted for inflation retroactively from a base year of 2010. Accordingly, in 2018, the estate and gift tax unified exemption will be $11.2 million per individual.
The Tax Act also doubles the exemption amount for generation-skipping transfers made in 2018 through 2025 to $10 million (from the current $5 million), adjusted for inflation retroactively from a base year of 2010.
As you can see, this is simply an overview of the major changes in corporate taxation, calculations for pass-through entities and individual tax impacts. For planning specific to your business entity structure and personal tax situation, please schedule an appointment to talk to our tax team at Schmidt Westergard. Keep watching for new tax updates as the Internal Revenue Service sorts out the details.