New Tax Law: What You Need to Know
Posted on 01.08.18
By Bryan Freshcorn, CPA, Tax Manager
With the signing into law of the Tax Cuts and Jobs Act (the Act), Congress has enacted the biggest tax reform law in thirty years, one that will make fundamental changes in the way you, your family, and your business calculate your federal income tax bill, and the amount of federal tax you will pay.
We have highlighted some of the new tax changes that individuals and businesses should be aware for 2018 and beyond. Please note that each taxpayer’s situation is unique and you should speak with your tax advisor before making any decisions.
For tax years 2018 through 2025, the following rates apply to individual taxpayers:
Taxable Income Over
Income Does Not Exceed
2018 Income Tax Rate
Head of Household
Taxable Income Over
Income Does Not Exceed
2018 Income Tax Rate
Married taxpayers filing joint returns and surviving spouses
Taxable Income Over
Income Does Not Exceed
2018 Income Tax Rate
Married taxpayers filing separately
Taxable Income Over
Income Does Not Exceed
2018 Income Tax Rate
Estates and Trusts
Taxable Income Over
Income Does Not Exceed
2018 Income Tax Rate
Unearned income of a child (the so-called “kiddie tax”) will be taxed at the estates and trusts rates and will not be affected by the income of their parents or siblings. For many, this will result in an increase in the kiddie tax.
Capital Gains and Qualified Dividends: The system for taxing capital gains and qualified dividends did not change under the Act, except that the income levels at which the 15% and 20% rates apply were altered (and will be adjusted for inflation after 2018). For 2018, the 15% rate will start at $77,200 for married taxpayers filing jointly, $51,700 for heads of household, and $38,600 for other individuals. The 20% rate will begin at $479,000 for married taxpayers filing jointly, $452,400 for heads of household, and $425,800 for other individuals.
Standard deduction: The Act increased the standard deduction through 2025 for individual taxpayers to $24,000 for married taxpayers filing jointly, $18,000 for heads of household, and $12,000 for all other individuals. The additional standard deduction for elderly and blind taxpayers was not changed by the Act.
Personal exemptions: The Act repealed all personal exemptions through 2025. The withholding rules will be modified to reflect the fact that individuals can no longer claim personal exemptions.
- Prepayment of taxes. With limitations coming in 2018, many taxpayers are looking to prepay taxes in 2017 to get the full deduction. However, the IRS just indicated that the prepayment of 2018 state and local real property taxes would ONLY be deductible on a taxpayer’s 2017 tax return if those taxes were assessed before 2018. Guidance issued by the IRS on December 27 (IR-2017-210) addressed this matter by clarifying that the tax must have been assessed. The language in the Act addressed income taxes but not property taxes.
- The new law substantially increases the alternative minimum tax (AMT) exemption amount, beginning next year.
- The itemized deduction for charitable contributions was not changed. But because most other itemized deductions will be eliminated in exchange for a larger standard deduction (e.g., $24,000 for joint filers), charitable contributions after 2017 may not yield a tax benefit for many because they won't be able to itemize deductions.
- Under current law, various employee business expenses, e.g., employee home office expenses, are deductible as itemized deductions if those expenses plus certain other expenses exceed 2% of adjusted gross income. Unfortunately, the new law suspends the deduction for employee business expenses paid after 2017, which can be significant for salespersons.
- Reduction in corporate income tax rate. For tax years that begin after Dec. 31, 2017, the corporate tax rate, which had been at graduated rates as high as 35%, is reduced to a flat 21% rate. Not only does this encourage pushing income into the new year, but it also should cause you to think about converting non–C corporation clients into C corporations, particularly those clients that do not qualify for the new deduction for pass-through income, discussed below. But note that, for corporations that are not personal service corporations and whose taxable income is less than $50,000, their marginal tax rate under the new law is higher than it was previously, so they generally would be better off pushing income into this year until they reach $50,000 of current year taxable income.
- Deduction for pass-through income. For tax years that begin after Dec. 31, 2017, pass-through businesses, e.g., sole proprietorships, partnerships, limited liability companies and S corporations, may be able to take a deduction of up to 20% of their business income. So, in most cases, this deduction will create an incentive to push income into the new tax year and expenses into the current year.
But this new provision is complicated. For example, “specified service trades or businesses,” e.g., businesses that involve performance of services in the fields of health, law, consulting, athletics, financial services and brokerage services, don't fully qualify unless the taxpayer's taxable income is equal to or below $157,500 ($315,000 for married individuals filing jointly) and don't qualify at all if the taxpayer's taxable income is above $207,500 ($415,000 for married individuals filing jointly). As a result, taxpayers who are in those businesses will not want to push income into the New Year if doing so will cause taxable income to exceed the above dollar amounts.
Taxpayers in specified service businesses whose taxable income is too high to qualify for the new deduction should consider incorporating and/or changing/expanding their business model so that they are not specified service trades or businesses. Note that the term “specified service trade” or “business” is defined in terms of already-existing Code Sec. 1202(e)(3)(A), so there is existing guidance on what is and what is not a specified service trade or business.
- Modification of the limit on excessive employee compensation. A deduction for compensation paid or accrued with respect to a covered employee of a publicly traded corporation is limited to no more than $1 million per year. However, under pre-Act law, exceptions applied for: (1) commissions; (2) performance-based remuneration, including stock options; (3) payments to a tax-qualified retirement plan; and (4) amounts that are excludable from the executive's gross income.
- For tax years beginning after Dec. 31, 2017, the exceptions to the $1 million deduction limitation for commissions and performance-based compensation are repealed.
So, taxpayers that are affected by these changes should: 1) to the extent practical, pay the types of compensation that were covered by an exception under the old rule but which no longer will be excepted, before the beginning of their new year; 2) reconsider their compensation policies for the new year and thereafter.
- Changes to net operating loss deduction rules. For net operating losses (NOLs) arising in tax years ending after Dec. 31, 2017, the current-law two-year carryback is, in almost all cases, repealed. As a result, increasing a current year NOL has a greater value, since creating such an increase will not only increase the client's refund from a carryback but also will be the client's last chance to get a carryback at all for the increased loss.
- For losses arising in tax years that begin after Dec. 31, 2017, the NOL deduction is limited to 80% of taxable income. NOLs incurred this year are not subject to this rule. So, it can be advantageous for a taxpayer with current year and future year losses to push deductions (such as bonus depreciation and pension plan contributions) into the current tax year and push income into next year.
- Expensing and depreciation. In general, taxpayers will want to accelerate the purchase of depreciable assets to take advantage of the 100% bonus depreciation provision included in the Act for property placed in service after Sept. 27, 2017. Also note that, under the Act, used property qualifies for bonus depreciation. Accelerating the purchase of qualifying property will offset income taxable at the 2017 higher tax rates.
- Like-kind exchanges. Generally effective for transfers after Dec. 31, 2017, Code Sec. 1031 like-kind exchanges are limited to transfers of real property not held primarily for sale. However, under a transition rule, the crackdown doesn't apply to exchanges of personal property if the taxpayer either disposed of the relinquished property or acquired the replacement property on or before Dec. 31, 2017
- Alternative minimum tax. For tax years that begin after Dec. 31, 2017, the corporate alternative minimum tax (AMT) is repealed. Therefore, corporations that would be subject to the AMT for a year before the repeal are likely to benefit by postponing transactions that result in AMT preferences or adjustments, and/or by not making elections that result in AMT preferences or adjustments, in that year.
- Repeal of domestic production activities deduction. For tax years that begin after Dec. 31, 2017, the domestic production activities deduction (DPAD) is repealed. DPAD is a deduction equal to 9% (6% in the case of certain oil and gas activities) of the lesser of the taxpayer's qualified production activities income or the taxpayer's taxable income for the tax year. Entities that are not C corporations, and that have income that would both increase their current year DPAD if it were recognized this tax year and would not increase their deduction for pass-through income (as described at “deduction for pass-through income” above) if it were recognized in a future year, will likely benefit by recognizing that income in this tax year.
- Liberalization of the long-term contract rules. Under current law, construction companies with average annual gross receipts $10 million or less, that meet certain other requirements, may use the more favorable completed contract method for recognizing income, rather than the less favorable percentage-of-completion method. For contracts entered into after Dec. 31, 2017, that $10 million figure is increased to $25 million.
Cash method of accounting: The Act expanded the list of taxpayers that are eligible to use the cash method of accounting by allowing taxpayers that have average annual gross receipts of $25 million or less in the three prior tax years to use the cash method. The $25 million gross-receipts threshold will be indexed for inflation after 2018. Under the provision, the cash method of accounting may be used by taxpayers, other than tax shelters, that satisfy the gross-receipts test, regardless of whether the purchase, production, or sale of merchandise is an income-producing factor.
Farming C corporations (or farming partnerships with a C corporation partner) will be allowed to use the cash method if they meet the $25 million gross-receipts test.
The current-law exceptions from the use of the accrual method otherwise remain the same, so qualified personal service corporations, partnerships without C corporation partners, S corporations, and other passthrough entities continue to be allowed to use the cash method without regard to whether they meet the $25 million gross-receipts test, so long as the use of that method clearly reflects income.
Inventories: Taxpayers that meet the cash-method $25 million gross-receipts test will also not be required to account for inventories under Sec. 471. Instead, they will be allowed to use an accounting method that either treats inventories as nonincidental materials and supplies or conforms to their financial accounting treatment of inventories.
UNICAP: Taxpayers that meet the cash-method $25 million gross-receipts test are exempted from the uniform capitalization rules of Sec. 263A. (The exemptions from the UNICAP rules that are not based on gross receipts are retained in the law.)
Expenses and Deductions
Interest deduction limitation: Under the Act, the deduction for business interest is limited to the sum of (1) business interest income; (2) 30% of the taxpayer’s adjusted taxable income for the tax year; and (3) the taxpayer’s floor plan financing interest for the tax year. Any disallowed business interest deduction can be carried forward indefinitely (with certain restrictions for partnerships).
Any taxpayer that meets the $25 million gross-receipts test is exempt from the interest deduction limitation. The limitation will also not apply to any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. Farming businesses are allowed to elect out of the limitation.
For these purposes, business interest means any interest paid or accrued on indebtedness properly allocable to a trade or business. Business interest income means the amount of interest includible in the taxpayer’s gross income for the tax year that is properly allocable to a trade or business. However, business interest does not include investment interest, and business interest income does not include investment income, within the meaning of Sec. 163(d).
Floor plan financing interest means interest paid or accrued on indebtedness used to finance the acquisition of motor vehicles held for sale or lease to retail customers and secured by the inventory so acquired.
Net operating losses: The Act limits the deduction for net operating losses (NOLs) to 80% of taxable income (determined without regard to the deduction) for losses. (Property and casualty insurance companies are exempt from this limitation.)
Taxpayers are allowed to carry NOLs forward indefinitely. The two-year carryback and special NOL carryback provisions were repealed. However, farming businesses are still allowed a two-year NOL carryback.
Like-kind exchanges: Under the Act, like-kind exchanges under Sec. 1031 will be limited to exchanges of real property that is not primarily held for sale. This provision generally applies to exchanges completed after Dec. 31, 2017. However, an exception is provided for any exchange if the property disposed of by the taxpayer was disposed of on or before Dec. 31, 2017, or the property received by the taxpayer in the exchange was received on or before that date.
Entertainment expenses: The Act disallows a deduction for (1) an activity generally considered to be entertainment, amusement, or recreation; (2) membership dues for any club organized for business, pleasure, recreation, or other social purposes; or (3) a facility or portion thereof used in connection with any of the above items.
Qualified transportation fringe benefits: The Act disallows a deduction for expenses associated with providing any qualified transportation fringe to employees of the taxpayer and, except as necessary for ensuring the safety of an employee, any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of employment.
Meals: Under the Act, taxpayers are still generally able to deduct 50% of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel). For amounts incurred and paid after Dec. 31, 2017, and until Dec. 31, 2025, the Act expands this 50% limitation to expenses of the employer associated with providing food and beverages to employees through an eating facility that meets requirements for de minimis fringes and for the convenience of the employer. Such amounts incurred and paid after Dec. 31, 2025, will not be deductible.
Partnership technical terminations: The Act repealed the Sec. 708(b)(1)(B) rule providing for technical terminations of partnerships under specified circumstances. The provision does not change the rule of Sec. 708(b)(1)(A) that a partnership is considered to be terminated if no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership.
Carried interest: The Act provides for a three-year holding period in the case of certain net long-term capital gain with respect to any applicable partnership interest held by the taxpayer. It treats as short-term capital gain taxed at ordinary income rates the amount of a taxpayer’s net long-term capital gain with respect to an applicable partnership interest if the partnership interest has been held for less than three years.
The conference report for the Act clarified that the three-year holding requirement applies notwithstanding the rules of Sec. 83 or any election in effect under Sec. 83(b).
Amortization of research and experimental expenditures: Under the Act, amounts defined as specified research or experimental expenditures must be capitalized and amortized ratably over a five-year period. Specified research or experimental expenditures that are attributable to research that is conducted outside of the United States must be capitalized and amortized ratably over a 15-year period.
Year of inclusion: The Act requires accrual-method taxpayers subject to the all-events test to recognize items of gross income for tax purposes in the year in which they recognize the income on their applicable financial statement (or another financial statement under rules to be specified by the IRS). The Act provides an exception for taxpayers without an applicable or other specified financial statement.
The Act modified some credits available to businesses. The House version of the Act would have repealed a large number of business credits, but the final Act generally did not repeal those credits. Changes to business credits in the final Act include:
Orphan drug credit: The amount of the Sec. 45C credit for clinical testing expenses for drugs for rare diseases or conditions is reduced to 25% (from the prior 50%).
Rehabilitation credit: The Act modified the Sec. 47 rehabilitation credit to repeal the 10% credit for pre-1936 buildings and retain the 20% credit for certified historic structures. However, the credit must be claimed over a five-year period.
Employer credit for paid family or medical leave: The Act allows eligible employers to claim a credit equal to 12.5% of the amount of wages paid to a qualifying employee during any period in which the employee is on family and medical leave if the rate of payment under the program is 50% of the wages normally paid to the employee. The credit is increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of payment exceeds 50%. The maximum amount of family and medical leave that may be taken into account for any employee in any tax year is 12 weeks. However, the credit is only available in 2018 and 2019.
Covered employees: Sec. 162(m) limits the deductibility of compensation paid to certain covered employees of publicly traded corporations. Prior law defined a covered employee as the chief executive officer and the four most highly compensated officers (other than the CEO). The Act revised the definition of a covered employee under Sec. 162(m) to include both the principal executive officer and the principal financial officer and reduced the number of other officers included to the three most highly compensated officers for the tax year. The Act also requires that if an individual is a covered employee for any tax year (after 2016), that individual will remain a covered employee for all future years. The Act also removed prior-law exceptions for commissions and performance-based compensation.
The Act includes a transition rule so that the changes do not apply to any remuneration under a written binding contract that was in effect on Nov. 2, 2017, and that was not later modified in any material respect.
Qualified equity grants: The Act allows a qualified employee to elect to defer, for income tax purposes, the inclusion in income of the amount of income attributable to qualified stock transferred to the employee by the employer. An election to defer income inclusion for qualified stock must be made no later than 30 days after the first time the employee’s right to the stock is substantially vested or is transferable, whichever occurs earlier.
Taxation of Foreign Income
The Act provides a 100% deduction for the foreign-source portion of dividends received from “specified 10% owned foreign corporations” by domestic corporations that are U.S. shareholders of those foreign corporations within the meaning of Sec. 951(b). The conference report says that the term “dividend received” is intended to be interpreted broadly, consistently with the meaning of the phrases “amount received as dividends” and “dividends received” under Secs. 243 and 245, respectively.
A specified 10%-owned foreign corporation is any foreign corporation (other than a passive foreign investment company (PFIC) that is not also a controlled foreign corporation (CFC)) with respect to which any domestic corporation is a U.S. shareholder.
The deduction is not available for any dividend received by a U.S. shareholder from a CFC if the dividend is a hybrid dividend. A hybrid dividend is an amount received from a CFC for which a deduction would be allowed under this provision and for which the specified 10%-owned foreign corporation received a deduction (or other tax benefit) from any income, war profits, and excess profits taxes imposed by a foreign country.
Foreign tax credit: No foreign tax credit or deduction will be allowed for any taxes paid or accrued with respect to a dividend that qualifies for the deduction.
Holding period: A domestic corporation will not be permitted a deduction for any dividend on any share of stock that is held by the domestic corporation for 365 days or less during the 731-day period beginning on the date that is 365 days before the date on which the share becomes ex-dividend with respect to the dividend.
Deemed repatriation: The Act generally requires that, for the last tax year beginning before Jan. 1, 2018, any U.S. shareholder of a specified foreign corporation must include in income its pro rata share of the accumulated post-1986 deferred foreign income of the corporation. For purposes of this provision, a specified foreign corporation is any foreign corporation in which a U.S. person owns a 10% voting interest. It excludes PFICs that are not also CFCs.
A portion of that pro rata share of foreign earnings is deductible; the amount of the deductible portion depends on whether the deferred earnings are held in cash or other assets. The deduction results in a reduced rate of tax on income from the required inclusion of pre-effective date earnings. The reduced rate of tax is 15.5% for cash and cash equivalents and 8% for all other earnings. A corresponding portion of the credit for foreign taxes is disallowed, thus limiting the credit to the taxable portion of the included income. The separate foreign tax credit limitation rules of current-law Sec. 904 apply, with coordinating rules. The increased tax liability generally may be paid over an eight-year period. Special rules are provided for S corporations and real estate investment trusts (REITs).
Foreign intangible income: The Act provides domestic C corporations (that are not regulated investment companies or REITs) with a reduced tax rate on “foreign-derived intangible income” (FDII) and “global intangible low-taxed income” (GILTI). FDII is the portion of a domestic corporation’s intangible income that is derived from serving foreign markets, using a formula in a new Sec. 250. GILTI would be defined in a new Sec. 951A.
The effective tax rate on FDII will be 13.125% in tax years beginning after 2017 and before 2026 and 16.406% after 2025. The effective tax rate on GILTI will be 10.5% in tax years beginning after 2017 and before 2026 and 13.125% after 2025.
Definition of U.S. shareholder: The Act amended the ownership attribution rules of Sec. 958(b) to expand the definition of “U.S. shareholder” to include a U.S. person who owns at least 10% of the value of the shares of the foreign corporation.
As mentioned previously, each taxpayer’s situation is unique and you should speak with your tax advisor before making any decisions. If you have any questions, please contact your Keiter representative or Email | Phone: 804.747.0000. We are here to help.
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