The Tax Cut and Jobs Act was President Trump’s first attempt at tax reform and makes major changes to both individual and business income taxation. Initially touted as simplifying tax code, it actually added more than 500 pages. Generally affecting tax years beginning after December 31, 2017, some provisions are intended to be permanent and some temporary, phasing out on December 31, 2025. Some experts believe the changes will not affect as many people as claimed, but there are some areas in which many businesses may experience an impact.
The new tax law is complex and can be confusing, so consider taking a deeper dive into the numbers before you file in April, and work closely with your CPA to model next year’s filing. Here are some things to keep in mind and discuss with your CPA regarding the new law:
Corporate rates change in that the previous structure with four rate brackets (15%, 25%, 34% and 35%) has been eliminated and replaced with a single flat rate of 21%. This will undoubtedly motivate many business owners to rethink their S Corporation election. But remember that, if you do so, you’ll be subject to double taxation – your corporation will pay income taxes and your shareholders will be taxed on dividends they receive.
Section 199A Deduction
Significant for closely held businesses are changes to the Section 199A Deduction. A deduction is allowed on the individual return based on your calculated qualified business income (QBI). The deduction is based on an aggregate of all qualified business income but to US income only. If the aggregate amount in the tax year is negative (aggregate loss) then this loss is carried forward as qualified business loss carryforward to the following year, which reduces the QBI for the following year. Changes have been made to QBI wage limitations and exclusions as well.
For bonus depreciation, new rules apply. Assets acquired during 2017 can elect 50% bonus whereas assets acquired after September 27, 2017 and before 2023 can elect 100%. It is no longer required that property be new. Changes have also been made to allowed amounts and, in some cases, time frames for depreciation.
The law repealed the Section 199 deduction after 2017. Some specific changes that will affect many businesses include disallowance of entertainment expenses, membership dues, and employee gifts unless they are included in the W-2. 100% of the cost of meals for employees could previously be deducted at 100%; beginning in 2018 that changed to 50%. R& D expenses must be capitalized and deducted over 5 years.
Business Loss Limitation
Starting in 2018, net business losses are not allowed in the current year but are carried forward as part of Net Operating Loss. This applies to net business losses in excess of $500,000 for those filing as Married Filing Jointly and $250,000 for others. For C Corporations, the Alternative Minimum Tax (AMT) has been repealed. The AMT credit carryforward offsets regular tax and is refundable. Previous C Corp rates of 15% to 35% have been replaced with a proposed flat rate of 21% which will result in a reduction for any C Corp with taxable income over $75,000.
Business Interest Limitation
Changes apply to businesses with gross receipts over $25 million but do not apply to real estate, public utilities and farming. Limits apply to business interest income PLUS 20% of taxable income from businesses before NOLs, 199A deductions, depreciation, amortization and depletion. Disallowed business interest is carried forward indefinitely. Changes expand the number of businesses that can use the cash method of accounting.
This tax legislation will also impact your exit strategy. Tax planning is a key component of exit planning, with the objective being to minimize taxes that affect your exit, including your personal wealth and estate planning.
What tax planning steps should you take to prepare for 2019 and to take a proactive approach towards exit planning?
- Have your accountant model your taxes for the 2019 tax year.
- Revisit your choice of entity.
- Reduce or eliminate guaranteed payments.
- Move from accrual to cash method of accounting if gross receipts are less than $25 million.
- Consider restructuring business debt if your interest deduction will be limited.
- Take the online assessment on my website at rjzinc.com/exit-planning-assessment/.
- Consider joining my Peer Advisory Board on Exit Planning.
- Meet with me in person or via Skype for an hour to review:
- Your exit planning assessment
- Exit readiness
- Ability to achieve your exit goals
- What it would take to put together an exit plan
Now is the time to begin developing both your tax strategy for 2019 and your exit strategy. It’s never too early to start thinking about your eventual exit. It will likely be the largest financial transaction of your life. The quality of planning will directly affect the quality of your life’s next chapter.