Near the end of 2017, the anticipation of tax reform made it difficult for taxpayers to implement tax planning strategies. As 2018 nears its end, taxpayers are in a similar situation as they anticipate further guidance on the provisions within the Tax Cuts and Jobs Act (TCJA).
Asset Acquisitions & Cost Recovery Provisions
Beginning January 1, 2018, the deduction allowed under Internal Revenue Code Section 179 is increased from $500,000 to $1 million and qualified asset purchases made after September 27, 2017, may qualify for 100 percent bonus depreciation under §168(k). There are specific rules for both §179 and bonus depreciation that should be considered during tax planning.
The allowable deduction under §179 now begins to phase out, dollar for dollar, once total asset purchases reach $2.5 million. Any allowable §179 expense in excess of taxable income is carried forward to the succeeding tax year. The increased expense amount and limitation threshold could prove valuable to small business taxpayers seeking to expand.
In general, asset acquisitions that are new or used—which is a significant change from prior bonus depreciation rules—with a recovery period of 20 years or less qualify for bonus depreciation. Unlike the §179 deduction, bonus depreciation can create a net operating loss (NOL) and, therefore, doesn’t have a carryforward period.
The immediate expensing of qualified assets may create current-year tax savings, but as part of tax planning discussions with their tax advisors, taxpayers should determine if immediate expensing is the right answer, especially considering the effects of other tax reform changes. For a closer look at the cost recovery provisions within the last year, check out our article Cost Recovery & Luxury Automobile Rules.
Entity Choice: C Corporation or Pass-Through
Beginning in 2018, the top C corp tax rate is permanently decreased from 35 percent to a flat 21 percent. The tax rate decrease brings into question whether there’s an incentive to convert from a pass-through entity to a C corp; however, taxpayers should keep in mind the effect of double taxation applicable to C corps and their owners. Recall that double taxation occurs when C corp owners are taxed on the dividend income received from the entity—income that’s already been taxed at the C corp level.
Section 199A, which potentially allows pass-through entity owners a maximum 20 percent deduction of domestic qualified business income, also is of interest to taxpayers. Not all pass-through income is eligible for the deduction and taxpayers should consult their tax advisor to verify.
On the surface, the lower corporate tax rate and §199A deduction both appear to provide tax benefits to entities and their owners; however, further analysis regarding future business environments, exit plans, owner compensation and other factors should be considered to determine the best entity choice. This one-page checklist can be used as a resource when performing this analysis.
Business Interest Expense Deduction
Prior to December 31, 2017, except under certain related-party situations, business interest expense was deductible when paid or accrued. In general, amended §163(j) now limits the deduction of all business interest expense to 30 percent of adjusted taxable income for taxpayers that meet the $25 million gross receipts test. Farming and real estate businesses should discuss the potential ability to elect out of the limitation with their tax advisor. All taxpayers with business interest expense will need to discuss the new §163(j) rules and calculations with their tax advisor.
Under previous law, NOLs could be carried back two years and forward 20 to eliminate 100 percent of a taxpayer’s regular taxable income in a single year. Section 172 was amended by the TCJA to restrict NOLs. Under current law, NOLs generated after December 31, 2017, can only be carried forward and are limited to 80 percent of taxable income. Taxpayers with NOLs generated prior to December 31, 2017, should consult with their tax advisor for assistance with applying NOL deductions and carryover rules while projecting taxable income.
Several other tax law changes for 2018 also should be considered during year-end planning. The corporate alternative minimum tax (AMT) was repealed and the use of AMT credits comes with limitations to restrict taxpayers from using carryforward credits to immediately eliminate all of their 2018 tax liability. While the research and development credit didn’t change for 2018, due to the interaction with other provisions, the lower tax rate means taxpayers could see an increased credit. Additional limitations for entertainment expenses also now apply under the new law. If your business has foreign operations, be sure to check out the International Tax Topics section of BKD’s 2018 Tax Advisor for an additional look at tax reform insights and planning opportunities that may exist.
Year-end tax planning for businesses differs from prior years where the primary goal was to defer income and accelerate expenses. Current planning with your tax advisor should focus on clarification and analysis of the TCJA’s provisions and application of the new law to your specific tax situation. Our “2018 Business Tax Year In Review” article provides more detail related to the planning topics above. The BKD Tax Reform Resource Center and Simply Tax podcast will provide updated tax reform information as it’s released.
Contact Brittany or your trusted BKD tax advisor for more information.