The Tax Cuts and Jobs Act, released on Nov. 2 and scheduled to be marked up by Ways and Means on Nov. 6, makes major changes to individual and business taxation. For businesses, the changes include a reduction in the corporate tax rate, expansion of expensing of business property, limits on deduction of business interest, and many other changes. These changes will generally be effective for tax years beginning after Dec. 31, 2017.
Changes to Corporate Tax Rates
Under the Act, the corporate tax rate would generally be a flat 20% rate beginning in 2018, eliminating the current graduated rates of 15% (for taxable income of $0-$50,000), 25% (for taxable income of $50,001-$75,000), 34% (for taxable income of $75,001-$10,000,000), and 35% (for taxable income over $10,000,000). The Act would provide that personal services corporations would be subject to a flat 25% corporate tax rate, rather than the current 35% rate, effective for tax years beginning after 2017.
100% Cost Recovery Deduction
Under the Act, instead of bonus depreciation for qualified property, taxpayers would be able to fully and immediately expense 100% of the cost of qualified property acquired and placed in service after Sept. 27, 2017 and before Jan. 1, 2023 (with an additional year for certain qualified property with a longer production period).
Property would be eligible for this immediate expensing if it is the taxpayer’s first use, repealing the current requirement that the original use of the property begin with the taxpayer. The Act would provide that qualified property would not include any property used by a regulated public utility company, or any property used in a real property trade or business.
Increased Code 179 Expensing
Under the Act, for purposes of Code Sec. 179 small business expensing, the limitation on the amount that could be expensed would be increased to $5 million (from the current $500,000), and the phase-out amount would be increased to $20 million (from the current $2 million), effective for tax years beginning after 2017 through tax years beginning before 2023. Both amounts would be indexed for inflation. The definition of section 179 property would also include qualified energy-efficient heating and air-conditioning property permanently, effective for property acquired and placed in service after Nov. 2, 2017.
Small Business Accounting Method Reforms
The Act provides several provisions reforming and simplifying accounting methods for small businesses.
Cash method of accounting. Under current law, a corporation or partnership with a corporate partner may only use the cash method of accounting if its average gross receipts do not exceed $5 million for all prior years (including the prior tax years of any predecessor of the entity). Under the Act, the $5 million threshold for corporations and partnerships with a corporate partner would be increased to $25 million and the requirement that such businesses satisfy the requirement for all prior years would be repealed.
Accounting for inventories. Under the Act, businesses with average gross receipts of $25 million or less would be permitted to use the cash method of accounting even if the business has inventories. In contrast, under current law, the cash method can be used for certain small businesses with average gross receipts of not more than $1 million (for businesses in certain industries whose annual gross receipts do not exceed $10 million).
Capitalization and inclusion of certain expenses in inventory costs. Under the Act, businesses with average gross receipts of $25 million or less would be fully exempt from the uniform capitalization (UNICAP) rules. The UNICAP rules generally require certain direct and indirect costs associated with real or tangible personal property manufactured by a business to be included in either inventory or capitalized into the basis of such property.
Accounting for long-term contracts. Under current law, an exception from the requirement to use the percentage-of-completion method is provided for certain businesses with average annual gross receipts of $10 million or less in the preceding three years. Under the Act, the $10 million average gross receipts exception to the percentage-of-completion method would be increased to $25 million, effective for tax years beginning after 2017. Businesses that meet the increased average gross receipts test would be allowed to use the completed-contract method (or any other permissible exempt contract method).
Limits on Deduction of Business Interest
Under the Act, every business, regardless of its form, would be subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’ adjusted taxable income. The net interest expense disallowance would be determined at the tax filer level. For example, it would be determined at the partnership level rather than the partner level. Adjusted taxable income is a business’ taxable income computed without regard to business interest expense, business interest income, net operating losses (NOLs), and depreciation, amortization, and depletion. Any interest amounts so disallowed would be carried forward to the succeeding five tax years and would be an attribute of the business (as opposed to its owners). Under the Act, businesses with average gross receipts of $25 million or less would be exempt from the above interest limitation rules.
NOL Deduction Limited
Under the Act, taxpayers would be able to deduct a net operating loss (NOL) carryover or carryback only to the extent of 90% of the taxpayer’s taxable income (determined without regard to the NOL deduction). This would conform to the current AMT rule. The Act would also generally repeal all carrybacks but provide a special one-year carryback for small businesses and farms in the case of certain casualty and disaster losses. This provision generally would be effective for losses arising in tax years beginning after 2017.
Business-related Exclusions, Deductions, etc.
Like-kind exchanges. Under the Act, the rule allowing the deferral of gain on like-kind exchanges would be modified to allow for like-kind exchanges only with respect to real property. Under current law, a special rule provides that no gain or loss is recognized to the extent that property – which includes a wide range of property from real estate to tangible personal property – held for productive use in the taxpayer’s trade or business, or property held for investment purposes, is exchanged for property of a like-kind that also is held for productive use in a trade or business or for investment.
Effective date. The provisions would generally be effective for transfers after 2017. A transition rule would allow like-kind exchanges of personal property to be completed if the taxpayer has either disposed of the relinquished property or acquired the replacement property on or before Dec. 31, 2017.
Entertainment and other expenses. Under the Act, no deduction would be allowed for entertainment, amusement or recreation activities, facilities, or membership dues relating to such activities or other social purposes.
The 50% limitation under current law also would apply only to expenses for food or beverages and to qualifying business meals under the Act provision, with no deduction allowed for other entertainment expenses.
Repeal of numerous provisions. The Act would also repeal a variety of business provisions including the deduction for income attributable to domestic production activities, for tax years beginning after 2017.
Repeal of numerous credits. The Act would also repeal a variety of business credits. It would repeal: the credit for clinical testing expenses for certain drugs for rare diseases or conditions; the employer-provided child care credit; the rehabilitation credit; the work opportunity tax credit; the new markets tax credit; and the credit for expenditures to provide access to disabled individuals.
For an update on the proposed individual tax changes in the Tax Cuts and Jobs Act, please read our related blog.