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Tax Cuts and Jobs Act Resource Center: Corporate and Business

  • Mar 14, 2018
  • Marc S. Maser
  • By Marc S. Maser

Back to the Tax Cuts and Jobs Act Resource Center.

The Tax Cuts and Jobs Act of 2017 (the Act) included a number of promised provisions to cut the corporate tax rate on a permanent basis, provide time limited tax cuts for individuals and incorporate a number of provisions that may change taxpayer behavior with respect to everything from housing choices to charitable giving to education. The final bill, passed by the Senate on December 20 and signed into law by President Trump on December 22, 2017, does not include other provisions that would have had a significant impact. 

For example, the Senate bill would have required that the cost of any specified security sold, exchanged, or otherwise disposed of after December 31, 2017, be determined on a first-in first-out basis except to the extent the average basis method is otherwise allowed. The bill would have provided an exemption for mutual funds. This proposed permanent change was a revenue raiser that would have front loaded gains for small investors who had held growth stocks for extended periods. It was dropped from the final bill. 

ACCOUNTING METHODS, COST RECOVERY AND EXPENSING

Accounting Methods (IRC Sections 448, 471, 481, 263A and 460)  

  • The Act increases the threshold for businesses in several areas, allowing corporations and partnerships and certain other taxpayers to retain the cash method of accounting, avoid inventory accounting rules and the UNICAP capitalization rules and provides more eligible taxpayers  with the ability to account for long term contracts under IRC Section 460. 
  • Taxpayers can change to or retain the accounting methods that provide for additional deferral of income if their average annual gross receipts for the last three completed tax years is less than $25 million (which will be indexed for inflation). The change substantially increases the threshold (from $5 million for cash accounting and $10 million for inventory accounting, UNICAP and Long Term Contracts). 
  • Any taxpayer that wishes to take advantage of the higher threshold and switch to the cash method must treat the switch as a change in accounting method under IRC Section 481. The IRS has substantial control over accounting method changes and guidance will be required. 

Depreciation and Expensing – Effects on Pass-Through Businesses (IRC Sections 168, 280F, 179, 467(e))

Temporary Expensing In Lieu of Depreciation. The Act temporarily extends the ability of businesses to expense 100% of certain qualified property acquired and placed into service after September 27, 2017 through December 31, 2022.

  • Beginning in 2023 and continuing through 2026, the first year bonus depreciation is reduced by 20 percent each year (80 percent for property placed in service in 2023; 60 percent for property placed in service in 2024; 40 percent for property placed in service in 2025; and 20 percent for property placed in service in 2026). There is no bonus depreciation for property placed in service after 2026.
  • The Act expands the scope of the property eligible for expensing to include television, film and broadcast productions. 
  • Qualified property generally includes tangible property with a depreciable life of 20 years or less as well as computer software. Moreover, computers and peripheral equipment are no longer treated as “listed property” subject to the more stringent substantiation requirements for deductibility and therefore are eligible for 100 percent depreciation expensing like other tangible property. 

Planning Considerations: 

  • Unlike prior law, the deduction is available for both new and used property (acquired from an unrelated original third party user) placed in service by the taxpayer.
  • In lieu of 100 percent first-year deduction for property placed in service during the first taxable year ending after September 27, 2017 (generally addressing companies whose taxable year ends on December 31, 2017), a taxpayer may elect to use a 50% deduction rate. A taxpayer may consider making this election if it is in an NOL position, the carry-forward of which may not be fully utilized in the early subsequent taxable years due to the 80% carry forward deduction limitation imposed under the new law.

Automobile Depreciation

  • The Act amends Section 280F of the Internal Revenue Code (IRC) to increase the depreciation limitations that apply for listed property. For passenger vehicles placed in service after December 31, 2017, and for which additional first-year depreciation is not claimed, the maximum amount of allowable depreciation is $10,000 for the first year and $16,000 for the second year. The amount drops to $9,600 in the third year, and $5,760 for the fourth and later years (in each case indexed for inflation). The provision is permanent.
  • Observations:
    • Taxpayers must affirmatively elect out of the bonus depreciation for each class of property. It is not an asset by asset election. Accordingly, opting out of first year depreciation for an automobile means that all five year MACRS property placed in service during the year will not be eligible for the bonus depreciation. It is still possible to expense eligible five year MACRS property under Section 179.
    • Taxpayers should elect out of first year bonus depreciation when possible if placing an automobile in service to maximize depreciation deductions over the shortest period of time. The bonus depreciation results in an additional $8,000 in depreciation in the first year, but the taxpayer must wait until the sixth year to claim additional recovery expenses.

Section 179 Deduction. The Section 179 deduction allows for the immediate expensing of qualifying Section 179 property in lieu of depreciation deductions.

  • For property placed into service after 2017, the maximum annual Section 179 deduction has been increased from $500,000 to $1 million (subject to further adjustment after 2018 for inflation indexing).
  • The ability to immediately expense qualifying Section 179 property starts to phase out when the aggregate amount placed in service during a taxable year exceeds $2.5 million (subject to further adjustment after 2018 for inflation indexing), up from the previous $2 million threshold.
  • Qualifying Section 179 property consists of depreciable tangible personal property purchased for use in the active conduct of a trade or business, including off-the-shelf computer software.
  • Passenger automobiles subject to the luxury automobile depreciation limitations are eligible for Section 179 deduction, but only to the extent of the dollar limitations related to the luxury automobile depreciation dollar limitations.
  • Sport utility vehicles having a weight rating in excess of 6,000 pounds but not more than 14,000 pounds are eligible for Section 179 deduction up to $25,000 (subject to further adjustment after 2018 for inflation indexing).
  • Personal property used to furnish lodging is now included as depreciable tangible personal property.
  • The Act also expands the definition of qualified real property to include all qualified improvement property (i.e., any improvement to an interior portion of a building which is non-residential real property provided that the improvement is placed in service after the date the building itself is placed in service) and certain improvements made to nonresidential real property (i.e., roofs, heating, ventilation, and air-conditioning property, fire protection and alarm systems, and security systems).

Planning Considerations. Taxpayers should utilize Code Section 179 to expense the cost of tangible property having longer depreciation periods in order to accelerate the recovery of their costs.

Real Estate Depreciation. The Act includes several favorable depreciation provisions for real estate owners of property placed in service after December 31, 2017. The recovery period is shortened for qualified improvement property to 15 years (assuming a technical correction is enacted) and reduces the alternative depreciation (applicable to those real estate trades or businesses electing out of the business interest expense limitation rules) to 20 years. The alternative depreciation recovery period for residential rental property is reduced from 40 years to 30 years. The alternative depreciation recovery period for nonresidential real property remains at 40 years.

DEDUCTIONS 

Limitation on Business Interest Expense Deduction (IRC Section 163(j))

  • The Act limits the ability of taxpayers to deduct business interest expense. Generally it is limited to the business interest income of the taxpayer plus 30% of the adjusted taxable income (i.e., EBITDA). For tax years starting after 2021, the taxpayer’s interest expense will be limited to 30% of earnings before interest and taxes. 
  • The net interest expense disallowance is determined at the tax filer level. However, a special rule applies to pass-through entities which require the determination to be made at the entity level (for example, at the partnership level instead of the partner level). Pass through entities with extra capacity for business interest deductions can give its owners the benefit of that capacity to deduct extra interest from other sources. If a pass through has disallowed interest expenses, the disallowed amount is passed through to the owners who can carry forward the deduction to later years.

Detailed Explanation: Although interest incurred in connection with a trade or business is generally deductible when accrued or paid, depending on the taxpayer’s method of accounting, the new tax law limits the amount of deductible interest in any taxable year. 

  • Deductible business interest expense (see definition below) for a taxable year cannot exceed the sum of the (i) taxpayer’s business interest income (see definition below), plus (ii) 30% of the taxpayer’s adjusted taxable income (see definition below), plus (iii) 100% of the taxpayer’s floor planning financing interest (i.e., relating to acquisition of motor vehicles).
  • “Business interest expense” is the amount of interest on indebtedness allocable to a trade or business, and therefore excludes “investment interest expense.”
  • “Business interest income” is the amount of interest includible in the taxpayer’s gross income that is allocable to its trade or business, and therefore excludes “investment income.”
  • “Adjusted taxable income” is an approximation for EBITDA or “earnings before interest, taxes, depreciation or amortization.” The technical definition states that “adjusted taxable income” is the taxpayer’s taxable income computed without regard to (i) non-business income, gain, deduction or loss, (ii) business interest or business interest income, (iii) any NOL deductions, (iv) the pass through income deduction added by Code Section 199A, and (v) for years beginning before January 1, 2022, deductions for depreciation, amortization or depletion. The cost recovery deductions must be taken into account for later years for budgetary reasons and will likely be the subject of extender legislation.
  • In the case of C corporations, no investment income or investment expense exists; therefore, all interest income and interest expense of a C corporation constitute business interest income and business interest expense.
  • Business interest expense that is not deducted in a taxable year on account of this interest deduction limitation may be carried forward indefinitely and deducted as business interest expense in a subsequent taxable year provided that the carryover amount and the business interest expense of the taxpayer in the subsequent year does not exceed interest expense limitation in that year.
  • Business interest expense limitation will not apply to small business entities (including real property trade or businesses) whose annual average gross receipts for the previous three taxable years do not exceed $25 million. 
  • This new interest deduction limitation provision supersedes and repeals the earnings stripping rules applicable to cross border loans.
  • A sole proprietorship or disregarded entity of an individual is considered an entity for business interest expense limitation purposes. An individual who performs services as an employee is not considered to be in engaged in a trade or business; therefore, his/her wages cannot be used to compute the “adjusted taxable income” of his/her sole proprietorship or disregarded LLC.
  • Pass-through entities have some special rules:
    • Partners can deduct additional business interest expense they paid or incurred outside of the partnership to reduce income from the partnership or other business sources in any year to the extent that the partnership in that year had business interest expense lower than its allowable limit for that year. For example, assume that AB Partnership has deductible business interest expense of $100 in a year, a business interest expense limitation of $210 (30 percent x $700) and adjusted taxable income of $700. Partner A, who owns a 50 percent interest in AB Partnership would receive his distributable share of AB Partnership income equal to $300 [50 percent x ($700 - $100)]. In addition, Partner A would receive his 50 percent allocable share of AB Partnership’s excess taxable income equal to $183.33 [((210 - 100 / 210) x $700) x 50 percent], which Partner A would be able to add to his adjusted taxable income for purposes of computing the amount of business interest expense that he could deduct in the same year. A similar rule applies to S corporations.
    • If the partnership has a disallowed interest expense, it is allocated to the partners who can carry it forward. Any carry forward interest expense can only be used to reduce taxable income from the partnership that generated the expense. It is not available to offset income from other sources.
    • The allocation of the interest deduction carryforward will reduce the partner’s basis (but not below zero) in his or her partnership interest but the subsequent use of the deduction does not trigger a second reduction. This carryforward in effect accelerates the impact on the outside basis of the partner’s interest in the partnership that would have occurred when the partner actually used the deduction. The partner can reclaim basis in his or her interest if he or she does not use the expense before he or she disposes of the partnership interest. The allocated business interest carryover rule does not apply to S corporations and their shareholders. 
  • A real property trade or business (including development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage) may elect out of the business interest expense limitation by making an irrevocable election at the time and in the manner to be prescribed by the IRS.

    • This election is available to real property trade or businesses operated by corporations and REITS.
    • If a real property trade or business makes this election, it will be required to use the alternative depreciation system (ADS) to depreciate non-residential property, residential rental property and qualified improvement property. The ADS generally decelerates the rate of depreciation and increases the length of the depreciation period.

Entertainment Expenses; Qualified Transportation Fringe Benefits (IRC Section 274)

  • For amounts paid or incurred after December 31, 2017, no deduction is allowed with respect to (1) an activity generally considered to be entertainment, amusement or recreation, (2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes, or (3) a facility or portion thereof used in connection with any of the above items.
  • The Act repeals the provision that allowed a deduction for entertainment, amusement, or recreation that is directly related to the active conduct of the taxpayer’s trade or business. Taxpayers may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals while traveling).
  • The Act also disallows a deduction for expenses associated with providing any qualified transportation fringe to employees of the taxpayer, and any expense incurred for providing transportation (or any payment or reimbursement) for commuting costs. There is a limited exception to provide for the safety of an employee, such as bodyguards and drivers for executives.
  • The Act extends the current 50 percent limit on the deductibility of business meals to those provided through an in-house cafeteria or on the employer’s premises. However, after December 31, 2025, no deduction is allowed for such expenses absent an extender by a later Congress.
  • Take Away: Sales forces will effectively be experiencing a budget cut. Corporate boxes at stadiums, tickets to golf tournaments and other client entertainment became more expensive as the expenditures are no longer deductible. 

Denial of Deduction for Sexual Harassment and Sexual Abuse Settlements (IRC Section 162)

  • In a provision ripped from the headlines, the Act disallows a business expense deduction for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement.
  • This provision took effect upon enactment of the bill.
  • The provision does not preclude a taxpayer from settling a case with a non-disclosure agreement, but the cost of the settlement cannot be treated as a deductible expense. The consequences may depend on how large a company is and whether it has financial disclosure obligations apart from the tax returns that would require it to identify the nature of any book/tax differences. 

Deductibility of Fines and Penalties for Federal Income Tax Purposes (IRC Sections 162 and 6005X)

  • Effective December 22, 2017, penalties and fines paid as the result of a governmental complaint or investigation for a violation or potential violation of a law are not deductible. 
  • The new rule does not apply to certain restitution payments and remediation costs that are intended to bring the payor into legal compliance. 
  • Restitution for tax payments is only deductible to the extent the payment would have been deductible if timely paid. 
  • There is a grandfather provision for amounts due to binding orders or agreements entered before the effective date. 

CAPITAL TRANSACTIONS

Like-Kind Exchanges (IRC Section 1031)

  • Effective December 31, 2017, IRC Section 1031 no longer applies to sales of tangible personal property.
  • Like-kind exchanges are still useful under the Act, but only for real property that is not held primarily for sale (i.e., no dealer inventory). 
  • There is a limited grandfather rule that applies if the first leg of a forward or reverse exchange was completed before December 31, 2017.

Self-Created Property (IRC Section 1221)

  • Effective for sales occurring after December 31, 2017, gain or loss from the disposition of a self-created patent, invention, model, design or other secret formula or process will be treated as ordinary in character rather than as capital gain.
  • Under the Act, a taxpayer may still treat a musical composition or copyright in a musical work as a capital asset. 
  • Observations: 
    • The Act puts technology in the same place that artists have occupied. A self-created tangible art work will generate ordinary income.
    • For corporations that own patents, the impact will be muted by the reduction in the corporate tax rate (see discussion below).
    • The provision could have an impact on exempt organizations that engage in technology transfer activities. IRC Section 512(b) excludes gains and losses from the sale, exchange or other disposition of property from the computation of Unrelated Business Taxable Income (UBTI). However, the exclusion does not apply to the sale of stock in trade or other inventory or to the sale of property held primarily for sale. Generally, this provision is treated as excluding from UBTI gain on the sale of capital assets (other than debt financed assets).  Notwithstanding the fact that the UBTI definition in the statute does not refer to the character of the gain as the determinative factor, it is possible that gain on the sale of self-developed intellectual property, now going to be characterized as “ordinary income,” will constitute UBTI. Gain attributable to straight line depreciation is treated as capital gain and avoids being UBTI. On the other hand, IRC Section 1250 recharacterizes recapture from accelerated depreciation as ordinary income and, under Treasury regulations, Section 1250 recapture income is also UBTI.
  • Planning: 

    • Individual inventors will have to structure the ownership of their intellectual property assets to take advantage of the pass-through income deduction. 
    • Alternatively, an inventor with few employees and more valuable assets may choose to contribute the IP assets to a corporation and eventually sell the stock. 

CREDITS

Rehabilitation Credit (IRC Section 47)

  • The rehabilitation credit prior to the effective date of the Act provides taxpayers with either a one-time 20 percent credit for rehabilitation expenditures associated with certain certified historic structures (i.e., listed on the National Register, located in an historic district or certified by Secretary of the Interior as having historic significance) or a one-time 10 percent credit for expenditures for the rehabilitation of any building placed in service before 1936.
  • For expenditures incurred or paid after December 31, 2017, the 10% credit for pre-1936 structures is eliminated and the 20% credit must be claimed ratably over a five year period. 
  • There is a limited transition rule for buildings (certified or pre-1936) owned by the taxpayer on and after January 1, 2018, if the taxpayer commences the rehabilitation expenditures on or before June 20, 2018.

Qualified Opportunity Zones (IRC Sections 1400Z-1, 1400Z-2)

  • The Act clarifies aspects of the current qualified opportunity zone tax credit and provides for some additional incentives for investment in qualified opportunity zone investments beyond the existing credit regime. 
  • First, each population census tract in each U.S. possession that is a low-income community is deemed certified and designated as a qualified opportunity zone effective December 22, 2017 .  In addition, governors (and the chief executive officer of the District of Columbia) can nominate opportunity zones for certification. 
  • Taxpayers may elect to temporarily defer capital gains that they reinvest in a “qualified opportunity fund” on or before December 31, 2026. The election is available only if the taxpayer reinvests the sale proceeds in a qualified opportunity zone within 180 days of the sale or exchange. A “qualified opportunity fund” is defined as an investment vehicle organized for the purpose of investing in a qualified opportunity zone and that holds at least 90% of its assets in “qualified opportunity zone property” (e.g., equity interests in entities that invest in a qualified opportunity zone). The amounts eligible for deferral are subject to a formula set out in the Act.
  • The deferral of gain will lapse on the earlier of when (i) the investment is sold or exchanged or (ii) December 31, 2026.
  • Depending upon how long the investment is held by the taxpayer, the amount of the deferred gain that must be recognized can be reduced. The maximum amount of the initially deferred gain that may be permanently excluded from taxation is 15 percent if the fund is held at least seven years.
  • A penalty applies to an investment fund that sought to be a qualified opportunity fund but fails to maintain the necessary level of investment in qualified opportunity zone property.  

CORPORATIONS

Corporate Tax Rate (IRC Section 11)

  • For tax years commencing in 2018, the corporate tax rate drops from the maximum 35% to a flat 21% rate. This flat rate applies to all C corporations, including personal service corporations taxed as C corporations. Multiple tax brackets no longer exist.
  • C corporations whose fiscal year straddles 2017 and 2018 will pay corporate income tax in proportion to the number of days in each calendar year. For example, if a C corporation has a fiscal year that ends on March 31, 2018, three-quarters of the taxable income for that fiscal year will be taxed at the old 35% rates and one-quarter of the taxable income will be taxed at 21% rates.

Corporate Alternative Minimum Tax

 The corporate alternative minimum tax (AMT) regime has been repealed. 

  • A corporation may carry-forward (but not carry-back) any unused minimum tax credit (MTC) remaining after 2017 to offset its regular income tax liability in each of its taxable years 2018 through 2021.
  • If a corporation has insufficient regular income tax liability in any of its taxable years beginning in 2018, 2019 and 2020 to absorb the MTC carryforward in full, 50% of any unused MTC carry-forward will be refunded to the corporation and the balance will be carried forward and used to offset the corporation’s regular income tax liability in the next succeeding year. If there still remains excess MTC in 2021 after offsetting the MTC carryforward against 2021 regular income tax liability, the corporation will be refunded 100% of any remaining excess MTC. These provisions effectively enable a corporation to use in full, by offset or refund, all of the unused MTC that is carried forward from pre-2018 taxable years.
  • Beginning in 2022, the rule in the Subchapter S regime that permitted the carryforward and application of the MTC against built-in gains taxes of an S corporation (formerly a C corporation) is eliminated. Until then, if an S corporation (former C corporation) incurs any built-in gain tax, the MTC carry forward will be available to offset the built-in gain tax. 

Dividend Received Deduction (IRC Section 243)

  • The dividend received deduction for dividends that a C corporation receives from a less than 20 percent owned corporation is reduced to 50 percent (formerly 70 percent). Similarly, a dividend received deduction for dividends that a C corporation receives from a 20-80 percent owned corporation is reduced to 65 percent (formerly 80 percent). The dividend received deduction does not apply to S corporations.

Net Operating Loss (NOLs) (IRC Section 172)

  • Except in the limited circumstances relating to NOLs incurred in connection with a farming business, NOLs may no longer be carried-back. They only may be carried forward and may be carried forward indefinitely.
  • The amount of NOL carry forward permitted to offset a taxpayer’s taxable income in a subsequent taxable year will be limited to 80 percent of such taxable income, computed without regard to the NOL deduction.
  • Should a taxpayer qualify as a real estate investment trust (REIT), “taxable income” for purposes of the 80 percent limitation is the REIT’s taxable income, computed without regard to the amount of dividends paid to the REIT shareholders.
  • Property and casualty insurance companies are neither subject to the 80 percent taxable income limitation for utilization of NOLs nor are they prohibited from carrying back NOLs. They are permitted to carryback NOLs two years and to carry forward NOLs twenty years against 100% of taxable income generated during that same period. 

Domestic Production Activities Deduction 

  • The domestic production activity deduction relating to certain qualifying U.S.-based activities is repealed.

Certain Contributions by Governmental Entities as Contributions of Capital (IRC Section 118)

A corporation does not have to include a contribution to capital as income.  Section 118 specifically states that contribution to capital does not include contributions in aid of construction or contributions by a potential customer except for certain limited situations involving public utilities. However, Section 118 was still seen as a way by which corporations avoided recognizing income on contributions by governmental entities, such as economic development lures. The Act retained Section 118 but clarified that all governmental “contributions” are taxable. Abatements of taxes are not considered contributions.

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DISCLAIMER: Although McCausland Keen + Buckman always strives to provide accurate and current information, the foregoing is intended for general informational purposes only, shall not be construed as legal advice, and does not create or constitute an attorney-client relationship.

Marc S. Maser

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Marc S. Maser

Marc helps clients buy and sell companies, and structure and finance tax-efficient domestic and foreign business transactions.

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