Reconciliation Update: 2017 Tax Reform Bill Business Impacts
Congress is now poised to pass the biggest tax reform since 1986. Both the House and the Senate have reconciled their different approaches to reform and the House has passed the reconciled bill on the morning of December 19, 2017. On the afternoon of December 19, 2017, the Senate parliamentarian determined that three provisions violated Senate rules. The House will have to remove those provisions and vote again before the bill moves to the Senate. The centerpiece reform is a reduction in the corporate tax rate. However, the bill also includes tax breaks for pass-through business income, and repeal of the corporate Alternative Minimum Tax (AMT). The following is a breakdown of the major changes. We will continue to monitor the events as the bill progresses.
Corporate Tax Rate ("C" Corporations Only): The final bill eliminates the current graduated income tax rates from 15% to 35% for businesses taxed as "C" corporations and instead institutes a flat tax rate of 21% regardless of taxable income. The change would be effective immediately for the 2018 tax year. Those C corporations reporting less than $50,000 in net taxable income could face a rate increase.
Pass-Through Income: The final tax bill contains a deduction for compliant pass-through income businesses (mainly those other than "C" Corporations). Those qualifying businesses owners can deduct 20% of their share of "business income." However, the bill incorporates numerous restrictions when determining business income. A taxpayer's 20% business income deduction is limited for taxable income above $157,500 if filing individually, or $315,000 if filing jointly. In such cases, the deduction cannot exceed 50% of that taxpayer's W-2 wages paid by the business, but that limit is phased in over the next $50,000 and $100,000 of taxable income, respectively. The bill also provides a more complicated alternative limitation calculation that incorporates the basis of property used in production of income. Generally the deduction is completely phased out for taxpayers that perform professional services (such as lawyers, accountants, and doctors-though engineers and architects are included) at the same threshold amount as 50% wage limit.
Alternative Minimum Tax: The final bill eliminates the corporate AMT.
Dividends-Received Deduction: Corporations are currently allowed to deduct 70% of the dividends they receive from other corporations. If a corporation owns over 20% but less than 80% of the dividend-paying corporation, it can deduct 80% of the dividends received. The bill reduces the allowable deduction from 70% and 80% to 50% and 65%, respectively. If the corporation owns over 80% of the dividend-paying corporation, it can deduct 100% of the dividends received. The bill will not change the range for the 100% dividend deduction. The reduction will go into effect immediately for the 2018 tax year.
Section 168k (Bonus Depreciation): Generally, the final bill would increase the first-year depreciation deduction under section 168k (bonus depreciation) from 50% to 100% and expand the category from new equipment and machinery to used and new equipment and machinery. The increase and expansion is only effective for property put in service after September 27, 2017 but before 2023. The final bill would gradually phase out the bonus depreciation by 20% a year over five years.
Section 179 Expensing: Generally, the current tax law allows businesses to deduct up to $500,000 of the cost of certain equipment acquired and put into service during the tax year. The final bill temporarily increases the small business expense cap from the previous limit of $500,000 to $1 million. The bill also increases the phase-out limit to 2.5 million. The Senate bill provision to shorten depreciation of real property did not survive reconciliation.
Entertainment Expenses: The final bill eliminates all entertainment expense deductions for business, including membership dues. The current system allows a 50% deduction. However, taxpayers may still, generally, deduct 50 percent of the food and beverage expenses associated with operating their trade or business.
Business Interest Expense: The final bill generally caps the deduction for business interest expense to an amount equal to the taxpayer's business interest income plus 30% of the taxpayer's "adjusted taxable income" for the taxable year. "Adjusted taxable income" is the taxable income without regard to (i) income, gain, deduction, or loss not allocable to a trade or business; (ii) business interest or business interest income; (iii) net operating loss; and, (iv) any amount deductible as pass-through business income. For taxable years before 2022, deductions for depreciation, amortization, or depletion are also excluded from the calculation of "adjusted taxable income."
Net Operating Loss Deduction: The final bill limits the net operating loss deduction to 80% of taxable income. The bill also eliminates the carry-back provision, but increases the carry forward period indefinitely (from 20 years).
Cash Accounting Rules: The final bill increases the eligibility of businesses to utilize the cash accounting rules to simplify their accounting. The bill increases the limit from $5 million average annual revenue up to $25 million.
U.S. Multinational Taxation: The final bill would change the rules of how U.S. multinational businesses are taxed, changing the current "worldwide" system to a "territorial" system, along with specific anti-abuse rules and base-erosion rules to prevent manipulation of the system. Further, the bill includes "deemed repatriation" provisions to require multinational businesses to pay a one-time tax rate (approximately 15.5% for cash and cash-equivalent and 8% for all others) on their existing overseas profits.