The big news for businesses is the reduction in corporate income tax rates. C Corporations previously were subject to graduated rates starting at 15%, rapidly increasing to 35%. Under the Tax Cuts and Jobs Act, signed into law December 22, 2017 the new corporate tax rate is a flat 21%.
The depreciation rules have drastically changed and are too complicated for this brief blog, but most depreciable assets you purchase (as in 100%) will most likely be deductible in the year of purchase, if you so choose. Section 179 depreciation has doubled to $1 million and first year Bonus Depreciation is 100% on new and used assets. There are still limitations on automobiles, though, so don’t go out and buy that Ferrari you’ve always wanted!
Now that I’ve shared the good news, let’s move on to the not so good news! Previously business interest was deductible. For tax years beginning after Dec. 31, 2017, every business, with average gross receipts of over $25 million, regardless of its form, is generally subject to a disallowance of a deduction for net interest expense over 30% of the business’s adjusted taxable income. The net interest expense disallowance is determined at the tax filer level. However, a special rule applies to pass-through entitles, which requires the determination to be made at the entity level, for example, at the partnership level instead of the partner level. Business interest can be carried forward indefinitely.
For Net Operating Losses arising in tax years ending after Dec. 31, 2017, the loss is limited to 80% of taxable income and, except in very rare cases, can only be carried forward.
Like-Kind Exchanges after December 31, 2017, will only be allowed for real property that is not held primarily for sale. Deferral of gain through a like-kind exchange on personal property, such as work vehicles will no longer be available.
Business can no longer deduct entertainment expenses. That means no more expensing your golf, sporting events, movie tickets or concerts! In addition, the 50% meal deduction has expanded to include meals provided by the employer on business premises. This basically means meals provided for the convenience of the employer, previously considered de minimus fringe benefits and deductible, are now cut in half.
Employee achievement awards, in cash, cash equivalents, gift cards, vacations, meals, etc. unless specifically included as in income on the employees W-2 will no longer be deductible.
The limit on excessive employee remuneration continues at $1 million dollars. However, the exceptions have tightened up so that most compensation falls under this rule.
One of the more complicated portions of this new act deals with pass-through entities. Most small businesses in the U.S. are pass-through entities which typically are Partnerships, S Corporations and Sole Proprietors reporting on Schedule C’s.
If your business is a pass-through entity, there is a new tax deduction of up to 20% of your net income. There are two limitations for all businesses:
- The deduction cannot exceed 50% of wages paid by the trade or business
- The deduction cannot exceed 25% of wages paid by the trade or business plus 2.5 percent of the original tax cost of certain depreciable assets (which is a capital limitation).
For businesses considered “exceptions,” this 20% deduction phases out when taxable income of the individual exceeds $157,500 for those filing single and $315,000 for those filing married joint.
The businesses considered exceptions are “any trade or businesses involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees.” The act specifically excludes engineers, architects, and those whose service consists of investing and investment management trading, or dealing in securities, partnership interests, or commodities!
This business deduction is good news for all pass-through entities. And for those owning businesses considered exceptions (which includes middle-income veterinary practice owners). You will get the 20% deduction, subject to the income limitations mentioned above of $157,500 (single) and $315,000 (MFJ).
I have also been asked if, due to the reduction in corporate tax rates, if you should consider changing your S Corporation to a C Corporation. I do not recommend it. There are too many down-sides. First, the dividends you take are not a deduction to the corporation and they are taxable to you, resulting in double taxation of 21% plus whatever you pay personally. Second, the only way to take money out of a C Corporation to avoid double taxation is through compensation. Every compensation dollar you take will incur payroll tax. With the S Corporation, you can take a reasonable salary and the remainder may be taken as distributions avoiding payroll tax and double taxation.
I will say however, that now is the time (after tax season), to ask your accountant if it makes sense to operate as an LLC or an S Corporation. In some cases, depending on your tax rate, the new 20% business deduction may give you more bang for your buck, than the savings in self-employment tax from being an S Corporation.
As you can see, this wasn’t necessarily a simplification act for business, but for most businesses, even veterinary practices, it is beneficial.
Please let me know if you have any questions. There’s a lot of changes with this act, and the really fun part is that it all goes back to the way it was before in 8 years!