Key Tax Reform Provisions Affecting Taxable Health Care Providers
Author: Andrea Lewman
The Tax Cuts and Jobs Act (TCJA) represents one of the most significant changes to the Internal Revenue Code in more than 30 years. While there are many implications to be addressed by all taxpayers, below is a discussion of key changes that will affect the taxable health care industry. These changes should be top of mind in the new year.
Taxpayers can now take a 100 percent bonus depreciation deduction for the cost of qualifying property acquired and placed in service after September 27, 2017, and before January 1, 2023. Beginning January 1, 2023, the deduction is phased down by 20 percent each year and sunsets after December 31, 2026. The new law expands qualifying asset purchases to include both new and used property with a tax recovery period of 20 years or less. Under previous law, only new asset purchases qualified for bonus depreciation. Unlike expensing allowed under Section 179, discussed below, bonus depreciation isn’t limited to taxable income and may be used to create a taxable loss in the current year. Bonus depreciation is automatically applied to asset purchases; therefore, taxpayers must elect out in years when the deduction may not be beneficial. Taxpayers also may elect to defer the change from 50 percent bonus depreciation to the default 100 percent deduction to qualified property placed in service after the first taxable year ending after September 27, 2017.
The new law also increases the maximum expensing limit under §179 from $520,000 to $1 million. If more than
$2.5 million of property is placed in service during the year, the $1 million limitation is reduced dollar-for-dollar for any purchases over $2.5 million. Both limitations are indexed for inflation after 2018. The §179 expense election also is expanded to include the following improvements to nonresidential real property made after the property was first placed in service: roofs; heating, ventilation and air-conditioning property; fire protection and alarm systems; security systems; and any other building improvements that aren’t elevators or escalators, don’t enlarge the building and aren’t attributable to internal structural framework. Consistent with prior law, §179 expensing can’t create a net operating loss (NOL) in the current year.
With the expanded definition of qualified property and 100 percent bonus depreciation deduction, health care entities likely will see larger tax depreciation deductions in years with large furniture and equipment purchases. To take advantage of the increased expensing at higher tax rates, care should be exercised in determining the placed-in-service date for asset purchases occurring after September 27, 2017. Likewise, there may be situations where it’s beneficial to elect out of bonus depreciation if the deduction may create a net loss.
Prior to January 1, 2018, the value of a qualified transportation fringe benefit provided by an employer to an employee was excluded from the employee’s income and deductible by the employer, subject to monthly limits. “Qualified transportation fringe” is defined as transportation in a commuter highway vehicle for travel between the employee’s residence and place of employment, transit passes, qualified parking and qualified bicycle commuting reimbursement. Effective January 1, 2018, the TCJA disallows any deduction for the expense of a qualified transportation fringe provided to an employee of the taxpayer. Note that these qualifying fringe benefits continue to be excludable from an employee’s wage; the employer is simply unable to deduct the cost incurred. An exception for qualified bicycle commuting reimbursements exists where the employee income exclusion is repealed while the corresponding deduction for the employer remains intact. This provision within the new law sunsets December 31, 2025. See our previous BKD Thoughtware® article for a closer look at some of the provisions affecting employers and employees.
Similarly, for amounts paid or incurred after December 31, 2017, deductions for entertainment expenses are disallowed, eliminating the subjective determination of whether the expense is sufficiently related to a business purpose. In addition, the 50 percent limitation on the deductibility of business meals is expanded to include meals provided through an in-house cafeteria or otherwise on the employer’s premises. It’s important to note that, for tax years beginning after December 31, 2025, the TCJA will disallow an employer’s deduction for expenses associated with qualifying meals provided for the employer’s convenience on the employer’s business premises or provided on or near the employer’s business premises through an employer-operated facility. For more information on the deductibility of meals and entertainment, see our Thoughtware article.
Health care entities providing transportation benefits to employees must prospectively add back the costs of these fringe benefits when determining taxable income. Costs of an on-site cafeteria or other meals provided for the taxpayer’s convenience must be separately identified and limited to a 50 percent deduction, noting that the full benefit of a deduction will be disallowed in tax years beginning after December 31, 2025.
Nonpassive Loss Limitation Rules
For tax years beginning after December 31, 2017, taxpayers may find that nonpassive losses from a flow-through activity are now subject to limitation. Under previous tax law, nonpassive losses derived from a flow-through entity were fully deductible if the amounts were at-risk and the taxpayer had sufficient tax basis to absorb the loss. Prospectively, however, the aggregate nonpassive annual loss deduction from all trades or businesses is limited to $250,000 for single taxpayers and $500,000 for married taxpayers filing jointly (MFJ). Any excess loss is treated as an NOL and indefinitely carried forward until used by the taxpayer.
Health care providers taxed as flow-through entities will need to consider the effect of potential tax loss limitations on their owners’ personal income tax returns in light of this provision. While all owners have unique circumstances and will need to consult with their tax advisors, the effect of various elections, e.g., bonus depreciation, made at the entity level could have a far-reaching effect when ultimately reported on the owners’ returns.
Effective for tax years beginning after December 31, 2017, and before January 1, 2026, §199A was added to the law to provide a deduction for a noncorporate taxpayer’s qualified business income (QBI) generated by certain qualifying pass-through activities. While the rules are complex and additional guidance is needed for proper implementation, the deduction is generally 20 percent of a taxpayer’s QBI from domestic partnerships, S corporations or sole proprietorships. A taxpayer’s QBI for a tax year is the net qualified items of income, gain, deduction and loss relating to any taxpayer’s qualified trade or business. If the calculated QBI is less than zero, the amount is carried over as a loss from a qualified trade or business to the succeeding tax year for purposes of calculating the QBI deduction in that year.
The QBI deduction is available, without limitation, to all noncorporate taxpayers generating income from a qualifying trade or business if the taxpayer’s taxable income doesn’t exceed $157,500 ($315,000 MFJ). When a taxpayer’s taxable income exceeds these thresholds, certain limitations apply. The QBI deduction is limited to the greater of 50 percent of W-2 wages paid with respect to the business or 25 percent of W-2 wages paid plus 2.5 percent of the unadjusted basis (immediately after acquisition) of all qualified property. In addition, if the taxpayer is engaged in a specified service trade or business, the deduction for those activities is subject to an additional phaseout. A specified service trade or business is one involved in the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, certain financial and investment services and any trade or business of which the principal asset is the reputation or skill of one or more of its employees or owners. The architecture and engineering fields are specifically excluded from this definition. As it’s currently written, the definition is broad and subjective. Additional guidance is necessary to properly identify which specific trades and businesses fall within the definition of a specific service business. BKD’s Pass-Through Business Deduction flowchart provides a summary of the calculation and its key elements.
Interest Expense Deduction Limitations
Effective for tax years beginning after December 31, 2017, business interest expense is now subject to a 30 percent deduction limitation. Under this limitation, the annual deduction for business interest expense can’t exceed the taxpayer’s business interest income for the tax year plus 30 percent of its adjusted taxable income. Adjusted taxable income generally is defined as taxable income from a trade or business before interest income or expense, NOL, any QBI deduction under §199A and, for tax years beginning before January 1, 2022, depreciation, amortization or depletion. Any disallowed interest expense may be indefinitely carried forward until fully used by the taxpayer.
Certain taxpayers are excluded from this limitation. If a taxpayer’s average annual gross receipts for the preceding three years don’t exceed $25 million (and aren’t considered a tax shelter prohibited from using the cash method), the limitation doesn’t apply. In addition, real property trades or businesses can make an irrevocable election to be excluded from this limitation. If the election is made, real property businesses must use nonaccelerated depreciation methods to depreciate any nonresidential real property, residential rental property and qualified improvement property. A similar election is available for farming businesses.
Corporate Income Tax Rate Decrease
Under previous law, corporations were taxed under a graduated rate system with a top rate of 35 percent. For tax years beginning after December 31, 2017, the TCJA enacted a flat 21 percent tax rate for corporate filers. A special blended rate rule applies for fiscal year corporations for tax years ending in 2018. The TCJA also eliminates the corporate alternative minimum tax.
Businesses in the health care industry or related fields that may not be qualifying trades or businesses for purposes of the QBI deduction (discussed above) may find benefit in converting from a pass-through entity to a corporation. This consideration may become more appealing to multistate taxpayers, as individuals are now subject to a $10,000 combined itemized deduction limitation for state and local income, real property and (if elected) general sales taxes paid. Corporations, on the other hand, can fully deduct all state and local taxes paid. Current distribution practices also affect this analysis. The pass-through structure favors higher distribution to owners, while the corporate structure becomes advantageous when distributions to owners represent a lower percentage of total earnings. As with any planning opportunity, customized tax modeling and long-term planning analyses must be performed using a taxpayer’s specific facts and circumstances prior to making any changes in entity structure.