This article summarizes changes made by the federal tax law enacted near the end of 2017, known as the “Tax Cuts and Jobs Act” (“TCJA”). This law substantially alters the tax landscape for business and non-business taxpayers. This article focuses on the major federal income tax changes affecting business taxpayers. This article does not discuss TCJA changes affecting the U.S. taxation of “cross-border” payments between a U.S. taxpayer and an affiliated taxpayer in another country.
[hfmaccordions][accordion title=”TCJA Summary”][hfmlists][li]For tax years after 2017 and before 2026, individual tax rates are: 10%, 12%, 22%, 24%, 32%, 35%, and 37%; four tax rates apply for estates and trusts: 10%, 24%, 35%, and 37%. The highest federal rate for individuals and trusts was 39.6% before 2018. Beginning in 2026, federal rates for individuals and trusts will revert back to pre-2018 rates unless Congress takes further action.[/li][li]For tax years after 2017, the federal rate for C corporations is a flat 21% (compared to graduated rates and a maximum rate of 35% in pre-2018 years). The 21% rate will not revert back to pre-2018 law like individual rates as summarized above. Taxpayers may consider converting from a sole proprietorship, partnership or S corporation to a C corporation to benefit from the 21% corporate rate, compared to a maximum individual federal rate of 37% (29.6% if a taxpayer qualifies for the 20% pass-through deduction summarized below). Other factors affect this “choice of entity” decision, including but not limited to, state and local income taxes, the frequency and amount of dividends or distributions to be paid (dividends paid by a C corporation are generally subject to an additional 23.8% tax at the shareholder level if and when distributed) and the 100% federal gain exclusion under Section 1202 (references to a “Section” in this article refer to the Internal Revenue Code) on the sale of “qualified small business stock” issued by a C corporation and held by the shareholder for more than five years. The accumulated earnings tax and personal holding company tax may increase a C corporation’s tax cost of accumulating earnings, rather than distributing, in some situations.[/li][li]After 2017, under Section 199A, non-corporate taxpayers may deduct 20% of “qualified business income” from a partnership, S corporation, or sole proprietorship, sometimes referred to as the “pass-through” deduction. The maximum federal rate on business income can be reduced from 37% to as low as 29.6%, depending on the circumstances.[/li][li]Deductions for business entertainment are disallowed after 2017. Taxpayers can deduct 50% of allowable expenses for business meals. IRS provided guidance on deductions for business meals in an entertainment context.[/li][li]After 2017, deductions for business interest expense are generally limited to the sum of: (i) the taxpayer’s business interest income for the year, (ii) 30% of the taxpayer’s “adjusted taxable income,” plus (iii) floor plan financing interest paid by vehicle dealers. This limitation did not apply before 2018. This is a significant change for taxpayers who finance their businesses with debt. Certain taxpayers with average annual gross revenues of $25,000,000 or less and taxpayers in real property businesses electing extended depreciation periods are not subject to these limitations.[/li][li]From 2018 through 2025, the annual federal deduction for state and local income and property taxes is limited to $10,000. The deduction for property taxes incurred in a business or income-producing activity is not subject to the $10,000 limit. C corporations are not subject to these limitations.[/li][li]From 2018 through 2025, an individual’s deduction for the aggregate net loss from all businesses against nonbusiness income (such as salary and investment income) is limited to $250,000 per year ($500,000 for joint tax returns), annually adjusted for inflation. “Excess business losses” above those limits are disallowed and added to the taxpayer’s net operating loss carryforward.[/li][li]Net operating losses from a trade or business (NOLs) in tax years beginning after 2017 cannot be carried back to earlier years but are carried forward indefinitely. The taxpayer’s deduction in the carryforward year cannot exceed 80% of taxable income in that year. NOLs arising before 2018 are carried back to the two preceding tax years and then forward 20 years; deductions for pre-2018 NOLs are not subject to the 80% limitation.[/li][li]Generally, for eligible property placed in service after September 27, 2017 and before 2027, bonus depreciation is increased to 100%. Beginning in 2023, the 100% amount gradually phases down.[/li][li]Section 179 now allows up to a $1 million annual deduction for eligible property placed in service during the year. The $1 million amount is reduced by property placed in service over $2.5 million during the year.[/li][li]After 2017, like-kind exchange treatment under Section 1031 is limited to exchanges of real property not held primarily for sale. Section 1031 no longer applies to exchanges of non-real property, such as vehicles, equipment and intangible assets.[/li][li]Gains reinvested in a “Qualified Opportunity Fund” can be temporarily deferred and, if the investment in the Qualified Opportunity Fund is held for 10 years, permanently excluded.[/li][li]After 2017, a corporation owing 20% or more of another corporation’s stock can deduct 65% of dividends received from the other corporation (80% before 2018). The deduction for a corporate shareholder owning less than 20% of the dividend paying corporation’s stock is reduced from 70% to 50%.[/li][/hfmlists][/accordion][/hfmaccordions]