The Tax Cuts and Jobs Act contains a bevy of tax breaks, and most business owners will come out ahead. However, some tax breaks were reduced or eliminated to make room for others. Here are some of the most significant changes for businesses:
- New 21 percent flat tax rate for corporations
The new law establishes a flat 21 percent corporate rate for businesses and personal service corporations. Previously, C corporations paid graduated federal income tax rates of 15 percent on taxable income of $0 to $50,000; 25 percent on taxable income of $50,001 to $75,000; 34 percent on taxable income of $75,001 to $10 million; and 35 percent on taxable income over $10 million. Personal service corporations paid a flat 35 percent rate.
- Deductions for ‘pass-through’ business income
Under the old rules, income from pass-through business entities (sole proprietorships, partnerships, S corporations and certain LLCs) was passed through to the owner and taxed at standard individual tax rates. The new law establishes a 20 percent deduction based on an owner’s “qualified business income,” subject to restrictions. The QBI deduction isn’t available for income from most service businesses (engineering and architecture firms are listed as exceptions), if the individual owner’s taxable income exceeds $157,000 ($315,000 for joint filers). The law also establishes a W-2 wage limitation on the deduction, with limitations, exceptions, and phase-in rules.
- Corporate AMT repeal
Previously, a corporate alternative minimum tax (AMT) was imposed at a 20 percent rate, although corporations with average annual gross receipts of less than $7.5 million for the preceding three tax years were exempt. The AMT has now been repealed.
- More generous Section 179 deduction rules
Section 179 of the Internal Revenue Code helps small businesses by allowing them to take a depreciation deduction for certain assets in one year, rather than depreciating them over a longer time period. The previous limit for a Section 179 deduction was $510,000, but now that limit is increased to $1 million. The new law expands the definition of eligible property to include certain personal business property, as well as qualified expenditures for roofs, HVAC equipment, fire protection and alarm systems, and security systems for nonresidential real property. The law also provides more generous first-year bonus depreciation rules for qualified property placed in service between September 28, 2017 and December 31, 2022.
- Cash accounting method available to more businesses
The new law increases the threshold for using the cash method from $5 million to $25 million. This makes the more flexible cash accounting method available to more medium-sized businesses.
- New limits on interest deductions
Generally, prior law established that a business’s interest expenses were fully deductible. Now, affected businesses can’t deduct interest expenses in excess of 30 percent of “adjusted taxable income.” For tax years 2018 through 2021, adjusted taxable income is calculated by adding back allowable deductions for depreciation, amortization and depletion. After 2021, those adjustments will no longer be made.
However, most taxpayers with average annual gross receipts of $25 million or less for the three previous tax years are exempt from the interest deduction limitation.
- Stricter rules on deducting losses
Deductions for net operating losses (NOLs) have been reduced, limiting the amount of taxable income that can be offset with NOL deductions from 100 percent to 80 percent.
- Stricter rules on meals and entertainment
Previously, businesses could deduct 50 percent of business-related meal and entertainment expenses. Plus, meals provided on the employer’s business premises were 100 percent deductible. Now, entertainment-related expenses are no longer deductible, and the deduction for on-premises meals has been lowered to 50 percent. After 2025, on-premises meals will be completely nondeductible.
- No deduction for commuter benefits
The new law no longer allows employers to take a deduction for subsidizing an employee’s commute, eliminating deductions for car services, parking allowances, and transit passes. Those benefits still remain tax-free to the employee.
While changes to the individual tax scheme are temporary, changes to the business tax scheme are permanent and comprehensive. Review and analysis will be ongoing as experts evaluate the potential opportunities and impact for businesses. Consult your tax professional for a full understanding of how these tax changes could affect you.