Changes Business Owners Should Know About the New Tax Law
Although the Tax Cuts and Jobs Act (TCJA) of 2017 brings a favorable lower tax rate to corporations, the Act also includes some new unfavorable rules affecting them as well. But it seemed clear that business owners were likely to see a shrinking tax bill. Here are the changes business owners should know about the new law that could affect their 2018 returns.
New Corporate Tax Rate is Lower
The headline numbers on corporate tax reform emphasized the decline from 35% to 21% in the top corporate tax rate. The way that most reports explained the reduction made it seem as though corporations never paid more than 35% of their marginal income in taxes. This change will live on past 2025, which is when most of the other tax law changes will expire. The new rate is also a flat tax, meaning it’s the same for all C corporations.
The Corporate AMT is Repealed
For tax years beginning after December 31, 2017, the corporate AMT is gone. Similar to the individual alternative minimum tax, corporate AMT was an additional way to calculate taxes to help ensure corporations paid a minimum amount of tax. Eliminating the corporate AMT also means getting rid of some of the tax liabilities such as certain dividends received deductions or a portion of the deferred gain on installment sales that used to factor into the AMT calculation.
Some Pass-Through Business get a Deduction
Pass-through businesses are entities like S corporations, partnerships and sole proprietorships whose profits pass through to the business owners, who then pay ordinary income tax on their personal returns. pass-through businesses will have a new tax situation beginning in 2018. A deduction of 20% of “qualified business income” (QBI) can be taken. Qualified business income is tied to the owner’s investment in the business, either in wages paid to employees or investment in capital assets bought and used in the business. Capital assets could be a business car, equipment, or furniture.
Business Deductions Changes
Starting in 2018, some key deductions that businesses have relied on are either going away or getting stricter requirements.
The TCJA eliminates the deduction for entertainment expenses, including activities such as taking a client or a prospect to sporting events, the theater, movies, concerts, and amusement parks. The act also eliminates deductions for expenses incurred for entertainment facilities (for example, a stadium suite or skybox) and for amounts paid for membership in any club organized for business, pleasure, recreation, or social purposes. The deduction for meals purchased during entertainment activities also is eliminated. Holiday party or similar social events for employees are still 100% deductible.
Businesses are allowed a 50 percent deduction for amounts paid for meals associated with the active conduct of the taxpayer’s trade or business. However, two changes made by the TCJA affect business meals. First, a definition for “business meal” was removed, and meals provided to employees traveling still are 50 percent deductible. Second, beginning on Jan. 1, 2018, the cost of meals provided for the convenience of the employer, such as meals provided to employees who need to be available throughout the mealtime, are 50 percent deductible. However, beginning on Jan. 1, 2026, no deduction will be allowed for meals for the convenience of the employer and for the cost, including meals, of operating an on-site dining facility.
Previously, any interest a business paid on business loans was generally deductible. The legislation places a limit on the amount of interest expense that businesses can deduct on their tax returns. Seen as a revenue-raiser to help pay for the corporate tax rate reduction, businesses, starting in 2018, can only deduct interest based on a formula. Starting in tax year 2018, businesses will generally not be able to deduct business interest expenses, which is considered any interest paid or accrued on indebtedness properly allocable to a trade or business, exceeding the sum of the following:
• Business interest income
• 30 percent of the adjusted taxable income of the business
• The floor-plan financing interest of the business
Net Operating Loss (NOL) Deduction
When a business reports operating expenses on its tax return that exceedS its revenues, a net operating loss (NOL) has been created. An NOL can be used in some other tax reporting period as an offset to taxable income, which reduces the tax liability of the reporting entity. In the past, if a business recorded a loss, it had the option to use those losses to either reduce any taxes paid in the past two tax years, or to reduce any future taxable income for the next 20 years. Under the new tax law, that NOL can only be carried forward, and is limited to 80 percent in any given year.
This is just an overview. With respect to questions about the value of incorporating and other planning issues, there is no one size fits all answer. A lot of these changes stand to benefit business owners, but you may have to make some adjustments to your business strategy to take full advantage of them. Make sure you consult with your tax and financial advisers to figure out how your particular business can utilize these changes.