TCJA’s Effect on Fiscal-Year C Corporation Contractors
The Tax Cuts and Jobs Act (TCJA) represents the largest change to federal tax code for individuals and businesses in more than 30 years. One of these changes was a dramatic reduction in the C corporation income tax rate from a maximum rate of 35 percent to a flat rate of 21 percent for tax years beginning after December 31, 2017. Therefore, calendar-year contractors with more than $50,000 of taxable income, operating as C corps, will be able to participate in this rate reduction starting with their 2018 year. For those contractors operating on a fiscal year-end, special rules apply when law changes are effective as of the beginning or end of a calendar year. Application of these rules to the TCJA’s reduction in C corp income tax rates results in a blended income tax rate for fiscal-year filers, depending on the date of the fiscal year-end. A table showing the blended rates based on various fiscal year-ends is attached here. As the table shows, fiscal-year C corp filers will be able to participate in the TCJA’s C corp income tax rate reduction, on a prorated basis, with the filing of their 2017 income tax returns (for fiscal years ending in 2018).
- Blended rate for fiscal filers
- Special rules apply when law changes are effective as of beginning or end of calendar year
- Example: Taxable income = $1,000,000
Note: The rule requiring fiscal-year S corps and partnerships to make deposits with the IRS under Internal Revenue Code (IRC) Section 7519—discussed below—doesn’t apply to fiscal-year C corps. This remains the case with the TCJA’s passage. Regardless, given the dramatic reduction in C corp income tax rates, contractors should revisit previously implemented tax savings strategies that use the income tax deferral opportunities available to fiscal-year C corps to determine how the rate reduction affects the benefits of the deferrals, e.g., payments of rent, compensation and interest to shareholders after December 31.
TCJA’s Effect on Fiscal-Year S Corp/Partnership Contractors
The requirement that S corps and partnerships operating on a fiscal year make a required payment under IRC §7519 wasn’t eliminated by the TCJA. IRC §7519 effectively requires a fiscal-year contractor operating as a pass-through to maintain a deposit with the IRS in the amount of the adjusted highest IRC §1 individual tax rate multiplied by the entity’s net base-year income. The adjusted highest IRC §1 individual tax rate is the highest individual rate in effect under IRC §1, as of the end of the base year, plus one percentage point. Base-year income is the corporation’s net income for the tax year preceding the elected fiscal year. So, for example, base-year income for a fiscal year ending on October 31, 2018, is the corporation’s income for the year ended October 31, 2017. The amount of the deposit for the October 31, 2017, base-year income deferral is due May 15, 2018. Given the language of IRC §7519, since the highest IRC §1 rate in effect as of the end of a base year ending in 2017 is 39.6 percent, the deposit due on May 15, 2018, will be calculated based on 40.6 percent of net income for the October 31, 2017, base year.
However, the highest IRC §1 individual tax rate for all tax years ending after December 31, 2017, and before 2026 will be 37 percent. This results in a 38 percent adjusted highest IRC §1 individual tax rate for all base years ending in 2018 through 2025. So, to the extent income and “applicable payments,” e.g., payments of rent, compensation and interest to shareholders, were deferred into calendar 2018 for base years ending in 2018, the required deposit will be 2.6 percent lower than it would be under pre-TCJA rules. Consequently, the deposit due on May 15, 2019, will be calculated based on 38 percent of net income for the October 31, 2018, base year.
Effect on the Construction Industry
With the demand and backlog for contractors appearing strong, and with competition stiffening, contractors are continually looking for ways to reduce and defer their income tax burden, including using fiscal years. With the TCJA’s passage, the fiscal year remains a valuable tool—especially for contractors experiencing significant and profitable growth.
Contact Jason or your trusted BKD advisor if you have questions