On December 20, Congress approved the Tax Cuts and Jobs Act, which provides sweeping changes for businesses, trusts, and individuals. President Trump signed the bill into law on December 22. The revised version of the bill carries the title “An Act to provide for reconciliation pursuant to Titles II and V of the concurrent resolution on the budget for fiscal year 2018.” However, the bill is still commonly referred to by its former name, the “Tax Cuts and Jobs Act.”
Following is a summary of some of the key changes affecting manufacturers and distributors along with some tax planning strategies that need to happen before the end of 2017.
Unless otherwise noted, the changes will be effective for tax years beginning after 2017. Keep in mind that these are federal changes and that state-level conformity on applicable items will remain to be seen.
Corporate and Business Provisions
- Creates a flat corporate income tax rate of 21%.
- Reduces the dividends received deduction:
- Previous 80% deduction (for stock ownership of 20% or more) reduced to 65%.
- Previous 70% deduction (for stock ownership of less than 20%) reduced to 50%.
- Repeals the corporate Alternative Minimum Tax (AMT):
- AMT credits carrying into 2018 will be utilized fully against regular tax with credits that exceed regular tax being refundable as follows:
-- 2018-2020 – 50% of the remaining AMT credit in excess of what is allowed against regular tax
-- 2021 – 100% of any remaining AMT credit is refundable
- Taxpayers meeting a $25 million (indexed for inflation) gross receipts test may:
- Be allowed to use the overall cash basis method of accounting.
- Be allowed to account for inventories as nonincidental materials and supplies or under a method that conforms to the taxpayer’s accounting treatment.
- Be exempt from uniform capitalization rules.
- Be exempt from using percentage-of-completion accounting method for long-term contracts to be completed within two years (completed-contract or other permissible method then allowed).
- Lobbying expenses before local government bodies (including Indian tribal governments) are no longer allowed for amounts paid or incurred on or after the date of enactment.
- Accrual method taxpayers must recognize income no later than the tax year in which such income is taken into account on an applicable financial statement or another financial statement under rules specified by the IRS (subject to exception for long-term contract income).
- Contributions to capital do not include: (1) any contribution in aid of construction or any other contribution as a customer or potential customer, and (2) any contribution by any government entity or civic group (other than a contribution made by a shareholder as such). Effective date depends on taxpayer circumstance.
- Permits full expensing of fixed asset purchases. One hundred-percent expensing is allowed for qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023. The “new property” requirement is removed and replaced with a taxpayer’s first-use rule.
- Luxury auto annual depreciation limits are increased to $10,000 for first year, $16,000 for second year, and $5,760 for fourth and later years (amounts indexed for inflation). For passenger autos eligible for bonus depreciation, the maximum first-year depreciation allowance remains at $8,000.
- Increases Section 179 expensing to $1 million. The phase-out amount will be increased to $2.5 million and indexed for inflation for tax years beginning after 2018.
- Section 179 is expanded to include qualified improvement property and certain improvements (roofs, heating, ventilation, and conditioning property, fire protection and alarm systems, and security systems) made to nonresidential real property.
- Depreciation recovery periods of 39 years and 27.5 years remain unchanged, and a singular Qualified Improvement Property category has been created, with a 15-year recovery period to consolidate several previously separate categories.
- Limits interest expense:
- The deduction for net interest expense incurred by a business is limited to 30% of the sum of the business’s “adjusted taxable income,” business interest income, and floor plan financing interest.
- “Adjusted taxable income” for 2018-2021 is computed without regard to depreciation, amortization, or depletion and without the former domestic production activities deduction.
- Business interest not allowed as a deduction will be carried forward.
- Exemption from limitation is provided for taxpayers with less than $25 million in average annual gross receipts.
- Domestic Production Activities Deduction (Code Section 199) has been repealed.
- Modifies net operating loss (NOL) deduction limitations. An NOL carryover or carryback will be limited to 80% of the taxpayer’s taxable income for losses arising in taxable years beginning after December 31, 2017. In addition, all carrybacks will be repealed except for a special two-year carryback in the case of certain losses incurred in the trade or business of farming, beginning after 2017. Losses arising in taxable years beginning after December 31, 2017, shall carry over indefinitely.
- Retains the Research and Development Tax Credit, Work Opportunity Tax Credit, Low Income Housing Tax Credit, and New Market Tax Credit. Employer credit for paid family and medical leave added for 2018 and 2019.
- After 2021, specified research and experimentation expenses must be capitalized and amortized ratably over a five-year period (15 years if conducted outside of the United States).
- Limits the use of like-kind exchanges. Code Section 1031 deferral of gain on like-kind exchanges will now be available only for real property.
- Disallows the entertainment deduction. No deduction (50% currently allowed) will be allowed for entertainment, amusement, or recreation activities, facilities, or membership dues relating to such activities. The 50% deduction for meal expenses associated with operating the trade or business is retained. Consider creating separate accounts for entertainment expenses that may be currently comingled with meal expenses.
- Fifty-percent deductibility of business meals is expanded to meals provided through an in-house cafeteria or otherwise on the premises of the employer. After 2025, the deduction for meals provided at convenience of employer on premises will be eliminated.
- Nondeductible expenses relating to amounts paid in relation to the violation of a law or investigation into the potential violation of a law, if a government (or similar entity) is a complainant or investigator with respect to the violation or potential violation, are expanded.
- Gain or loss from the disposition of a self-created patent, invention, model or design, or secret formula or process will be ordinary in character (not a capital asset).
- Introduces a new 20% deduction relating to qualified business income (QBI) from a partnership, S corporation, or sole proprietorship of noncorporate taxpayers (including individuals, trusts, or estates) for 2018 to 2025:
- QBI activities of a taxpayer are combined for figuring the deduction.
- The deduction does not reduce AGI (a below-the-line deduction).
- At taxable income of $157,500 for an individual ($315,000 joint return), a limitation is phased in to cap the deduction at 50% of W-2 wages paid (or 25% of W-2 wages paid plus a capital allowance).
- The deduction phases out for a specified service business when an individual’s taxable income exceeds $157,500 ($315,000 joint return).
- QBI does not include reasonable compensation or guaranteed payments to the taxpayer from the business.
- Partnership technical termination rule has been repealed.
- Foreign persons’ gain or loss on sale or exchange of interests in partnerships engaged in trade or business within the United States may require a 10% withholding on the amount realized in a hypothetical asset sale by the partnership.
- Substantial built-in loss definition is expanded for transfers of partnership interests.
- Excess business losses that will be determined at the partner or S-corporation shareholder level will be carried forward under NOL rules. An excess business loss will be determined as a trade or business loss in excess of income or gain of the taxpayer plus $250,000 ($500,000 joint return).
- Carried interest – To qualify for long-term capital gain on the sale of a partnership interest received in exchange for services, the taxpayer must now hold that partnership interest for a three-year period
- Allows 100% deduction for foreign-source portion of dividends received from “specified 10-percent owned foreign corporations” by U.S. corporate shareholders. No foreign tax credit (or deduction) is permitted on such dividend.
- The availability of the deemed foreign tax credit that was available for domestic C corporations is eliminated, except for dividends attributable to Subpart F income inclusion.
- Deferred foreign income upon transition to new system will be subject to a deemed repatriation tax in the last tax year beginning before 2018:
- Portion of foreign E&P comprising cash or cash equivalents is taxed at a reduced rate of 15.5%.
- Any remaining E&P is taxed at a reduced rate of 8%.
- Election is available for tax liability to be paid over a period of up to eight years.
- Special rules for S corporations may allow deferral to be maintained.
- Foreign taxes paid or accrued as a result of the deferred earnings and profits inclusion are limited to those foreign taxes in proportion to the taxable portion of the Subpart F deemed dividend.
- Separate foreign tax credit limitation basket is created for foreign branch income.
- Gains, profits, and income from sale or exchange of inventory property produced partly in, and partly outside, the United States must be allocated and apportioned on the basis of the location of production with respect to the property.
- The profits from sale of inventory property being solely based on production location eliminates the 50/50 split of Code Section 863(b) sourcing.
- The provision for tax-free transfer of property to a controlled foreign corporation that is to be used in an active trade or business is repealed.
- Current-year inclusion of global intangible low taxed income (GILTI).
- Deduction for foreign-derived intangible income and GILTI.
- Addition of “base erosion anti-abuse tax” for certain corporations with average annual gross receipts of at least $500 million.
- Interest expense allocated among members of U.S.-affiliated group will be based on adjusted basis of assets.
- Excise tax on stock compensation in a corporate inversion will be increased to 20%.
Time Is Running Out: What to Do Before December 31, 2017
With reduced tax rates in 2018, the general theme for planning is “defer income and accelerate deductions.” Planning should be discussed with your Wipfli tax professional, and you should never spend a dollar to save 40 cents in taxes, but when it makes sense you should consider:
- Prepaying expenses that are deductible for tax purposes, assuming you have adopted the accounting method to deduct certain prepaid expenses when they are paid.
- Accelerate fixed asset purchases that can be 100% written off.
- Consider a cost segregation study for buildings (those placed in service in 2017 as well as over the past few years if cost segregation was not previously done) to accelerate depreciation.
If you have questions regarding the information above, contact your Wipfli relationship executive.