Small business tax updates
Navigating the new tax law
Scott W. Clouse, CPA
The tax law changed drastically with the introduction of the Tax Cuts and Jobs Act (TCJA) at the end of 2017. Most of the updates took effect at the beginning of 2018, so this is the first time you’ll file your tax return under the new rules. As a business owner, it’s important to be aware of the changing tax landscape so you can position your company in the most tax advantageous way possible. Let’s discuss some of the business tax changes that will impact you.
Bonus depreciation allows businesses to immediately recover a large portion of their capital expenditures through accelerated depreciation deductions. This incentive first came into the tax law for assets placed in service after September 10, 2001. The percentage allowed as accelerated depreciation has varied throughout the years.
TCJA increased bonus depreciation to 100% with a phase-down for qualifying new and used property acquired and placed in service after September 27, 2017 and before 2023 (2024 for certain property with longer production periods and certain aircraft). Property is not acquired after September 27, 2017 if a written binding contract for its acquisition was entered into on or before that date – which can come as a surprise to some taxpayers, so keep this in mind when making capital expenditure decisions. Bonus depreciation rates will phase-down to:
- 80% in 2023
- 60% in 2024
- 40% in 2025
- 20% in 2026
For property with a longer production period, and certain aircraft, the phase-down is:
- 80% in 2024
- 60% in 2025
- 40% in 2026
- 20% in 2027
The popular Section 179 expensing has been expanded under TCJA. For taxable years beginning after 2017, the expensing limitation is $1 million (up from $510,000 in 2017), subject to a phase-out limit that has been increased to $2.5 million. These amounts will be indexed for inflation annually. The deduction now applies to qualified improvement property and some improvements to nonresidential real property such as roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems. Improvements that qualify for Section 179 expensing must be placed in service after the date the original property was placed in service.
Opportunity Zone Tax Incentive
The new tax law also included a tax incentive to spur investments in distressed areas throughout the United States. The Opportunity Zone Tax Incentive provides temporary deferral of inclusion in gross income for gains reinvested in a Qualified Opportunity Fund (QOF) and the potential permanent exclusion of gains from the sale or exchange of an investment in a QOF. Qualified property held by the fund would include equity in businesses, real estate and business assets that are in a Qualified Opportunity Zone.
The Opportunity Zone Tax Incentive allows a taxpayer with a capital gain to elect to exclude that gain from gross income to the extent of the amount of cash invested by the taxpayer in a QOF. This investment must take place within 180 days of realizing a capital gain to qualify for the deferral.
If the QOF investment is held for five years before December 31, 2026 arrives, then 10% of the original deferred gain will be permanently excluded from tax. If the investment is held seven years before December 31, 2026, an additional 5% will be permanently excluded from tax. On December 31, 2026, any remaining deferred gain must be included in taxable income at that time.
Additionally, if the QOF investment is held for 10 years, tax basis in the QOF interest gets a step-up to current fair market value. This effectively allows you to avoid taxes on any post acquisition appreciation on the QOF interest. Additional requirements and benefits exist that are beyond the scope of this article. But QOFs can be a powerful investment vehicle and should be taken seriously.
Safe harbor for SALT deduction
Individual taxpayers are now limited to $10,000 annually when deducting state and local tax payments as itemized deductions. Taxpayers have been searching for charitable deduction workarounds to circumvent this new limitation. Some states have programs where a credit is given against state and local taxes for certain charitable donations made by the taxpayer. In some situations, pass-through entities were able to make charitable donations that reduced the state income tax liability of the individual owners.
Questions have lingered since proposed regulations on August 27, 2018 were released, effectively limiting the deduction of such charitable payments. The proposed regulations generally state that if a taxpayer makes a payment or transfers property to, or for the use of, a charitable organization, and the taxpayer receives, or expects to receive a state or local tax credit in return for such payment, the tax credit constitutes a return benefit, or quid pro quo, to the taxpayer and reduces the taxpayer’s charitable contribution deduction.
Now, the IRS has provided a safe harbor for businesses in determining the deductibility of such charitable payments. If the payment reduces state and local taxes (other than income taxes) at the pass-through entity level (not the owner level), then the payment will be deductible as an ordinary and necessary business expense. This still does not provide a workaround for the $10,000 limitation at the individual level since a deduction is only allowed if the state tax is imposed at the entity level. If the entity had opted to pay the state tax, rather than reducing it through charitable contributions, the state tax would have ordinarily been a deductible expense at the entity level. They are simply trading out a state tax deduction for a charitable deduction.
Excess business loss rules
New business loss rules apply for taxpayers, other than C Corporations, in tax years beginning after December 31, 2017 and before January 1, 2026. Your “excess business loss” for the tax year, if any, is disallowed. An excess business loss is the excess of your aggregate deductions for the tax year that are attributable to trades or businesses, over your aggregate gross income, or gain attributable to those trades or businesses, plus a threshold amount.
The threshold amounts for 2018 are $250,000 for single filers and $500,000 for married filers. Beginning after 2018, these thresholds will be indexed for inflation. In layman’s terms, a married couple can only use $500,000 of current year business losses to offset non-business income on their personal tax return. Any disallowed excess business loss is treated as a net operating loss and is carried over to the following tax year.
Don’t miss out!
Please take the time to consult with your Henry+Horne tax advisor concerning these and other new incentives and tax law updates. Steps can be taken now to potentially reduce your exposure to tax and increase cash flow into your pocket.