What provisions of the Tax Cuts and Jobs Act (“TCJA”) will have the biggest impact on businesses in the technology, health and life sciences, and manufacturing and distribution sectors.
The answer is: Potentially dozens. There are a lot of big changes and important items to highlight. So, use this list as a quick reference guide to find the topics that will be the most likely to affect you and your organization.
Large-Scale Corporate Tax Changes
Corporate tax rate is now a flat 21 percent. This new flat rate will hopefully save corporations money and lead to simpler tax calculations.
Corporate Alternative Minimum Tax (“AMT”) has been repealed. By repealing corporate AMT, a taxpayer’s election to accelerate AMT credits in lieu of bonus depreciation is also repealed. On the other hand, if you have AMT credits leftover from previous years, existing AMT credits may be recovered by using against corporate income tax or may be refunded.
Net operating losses (“NOLs”) can no longer be carried back. The old rules allowed NOLs to be carried back for two years and carried forward for 20 years. NOLs could also be used to offset 100 percent of a taxpayer’s taxable income, barring any other limitations (such as section 382 limitations). Under the TCJA, new NOLs that arise in taxable years beginning after December 31, 2017, cannot be carried back anymore, but they can be carried forward indefinitely. NOLs that arise in taxable years ending after December 31, 2017, are limited; they can only offset 80 percent of taxable income. Old rules will generally apply to NOLs generated in tax years starting before December 31, 2017.
Enhancements and Limits to Business Deductions
Interest expense deduction limited
Beginning in 2018, interest expense is limited to 30 percent of adjusted taxable income. Before 2022, adjusted taxable income will include add-back of interest, depreciation, amortization, and depletion. For later tax years, the definition changes and no adjustments will be made for depreciation, amortization and depletion. Any interest expense that is not deductible in the current year is carried forward indefinitely. The analysis to determine how much interest is allowed is made by the business entity (e.g., partnership, S corporation) under the new law.
Additional Reading: Planning for the New Business Interest Expense Deduction Limitation
100 percent bonus depreciation and expanded section 179 expensing
Enhancements to bonus depreciation are the only provisions in the TCJA that are retroactive to September 28, 2017. The TCJA extends and modifies the availability of first-year additional depreciation for qualified property placed in service after September 27, 2017, and through December 31, 2022. The first-year percentage increased to 100 percent, and it now applies to both new and used property. The first-year bonus percentage will phase down beginning in 2023 and will sunset at the end of 2026.
The TCJA enhanced section 179 expensing by increasing the maximum annual amount a taxpayer can expense up to $1 million (with the phase-out threshold increased to $2.5 million). It also expanded the definition of qualified real property eligible for expensing to include:
- Certain improvements made to nonresidential real property after the property was first placed in service (e.g., roofs, HVAC property, fire protection, security systems)
- Qualified improvement property
Other business deductions
The trade-off for a lower corporate rate, no AMT, and immediate capital investment expensing is that some of the corporate write-offs businesses previously enjoyed have been eliminated.
- The Domestic Production Activities Deduction, or DPAD, is eliminated.
- Compensation paid to certain executives of publicly traded companies is still limited to $1 million. The new tax law expands the definition of compensation to include performance-based compensation, expands which companies are subject to the limit and expands the employees and officers included in the definition of “covered employees.”
- Entertainment expenses may no longer be deducted.
- The 50 percent limit on the deductibility of meals now applies to an in-house cafeteria on the premises of the employer.
- No deduction is allowed for employee transportation fringe benefits (including parking and mass transit), but these fringe benefits are generally still tax free to the employee.
Simplification Provisions
Accounting methods for business
Businesses with less than $25 million in average annual revenue may benefit the most under the TCJA. The simplification provisions that apply to these taxpayers permit use of the cash method of accounting, simplified inventory accounting methods and the completed contract accounting method for long-term contracts. These accounting methods can create more flexibility in tax planning and will provide for easier recordkeeping and reporting requirements for these businesses. Additionally, businesses with less than $25 million in annual revenue will not be subject to the limit on business interest expense deductions discussed above.
Qualified Business Income Deduction
New section 199A deduction
Section 199A qualified business income (“QBI”) is one of the more complex provisions of the new law. In brief, a noncorporate taxpayer may deduct up to 20 percent of domestic qualified business income from a partnership, S corporation or sole proprietorship. This deduction can effectively lower the top individual tax rate from 37 percent to 29.6 percent on pass-through business income. There are limits on the QBI deduction due to income from specified service businesses, as well as limits that are derived from W-2 wages and the costs of depreciable tangible property.
Many questions surround this new section of the Internal Revenue Code, and the Internal Revenue Service (“IRS”) has been asked to provide guidance for a number of these questions as soon as practical. To help partners and S corporation shareholders to claim the QBI deduction, pass-through businesses will need to maintain new tax reporting records and section 199A information to supply along with their Schedules K-1 each year.
Research & Development
Great news for innovative companies of all sizes – the Research and Experimentation Tax Credit (“R&D credit”) made permanent in the Protecting Americans from Tax Hikes Act of 2015 (“PATH Act”) is preserved in the TCJA. Given the focus many sectors have on inventing, innovating and developing new products, services and processes, retaining the R&D credit is seen as a big win.
TCJA did make one change to R&D expense deductions. For tax years beginning after December 31, 2021, specified research and experimentation expenses must be capitalized and amortized ratably over a five-year period. The amortization period is extended to 15 years for research conducted outside of the United States. Specified expenses for this provision include expenses for software development.
Treatment of patents
Self-created patents are not included in the definition of capital assets under the new tax law. The list of exceptions also includes inventions, models or designs, and secret formulas and processes. The disposition of these intangibles will not receive capital gain treatment after December 31, 2017.
Federal Tax Credits
The R&D credit isn’t the only substantial credit out there. Here are status updates on other important Federal tax credits under the new tax reform law:
Unused Business Credits: These credits are preserved in the new tax law.
Paid Family and Medical Leave Credit: The TCJA offers a new tax credit for businesses that offer paid family leave benefits. For every hour of paid leave that employers provide to eligible employees, the employers can receive a 25 percent nonrefundable tax credit up to $4,000 per employee per year. In order to qualify for it, employers are required to provide two weeks of paid family leave that replaces at least 50 percent or more of an employee’s full-time wages (and a prorated amount of leave to part-time employees). Employers can only take the credit for employees who make less than $72,000 annually. This credit is only available for two years through the end of 2019.
International Tax Law
For multinational businesses, there’s a whole other set of considerations in the TCJA. Companies face new decisions on where in the world to locate their intellectual property, as well as what do a U.S. territorial tax system and base erosion profits shifting rules mean for intercompany transactions of multinational organizations. A few of the top highlights are:
- Mandatory deemed repatriation of post-1986 undistributed foreign earnings and profits (“E&P”): When calculating the tax under this provision, different rates apply depending on the extent to which accumulated deferred E&P is held in cash or non-cash assets. Taxpayers can choose to pay the tax owed in as many as eight installments if an election is filed on time, and S corporations can choose to defer payment until a triggering event.
- Global intangible low-taxed income (“GILTI”) of controlled foreign corporations (“CFCs”): The GILTI tax generally results in taxation of a U.S. shareholder on the combined net income of its CFCs, income that is not otherwise taxed in the U.S. on a current basis. The threshold for when this tax applies is when the CFC income exceeds a fixed return on its business assets.
- New section 250: For tax years beginning after December 31, 2017, U.S. C corporations are allowed a deduction of 37.5 percent of foreign-derived intangible income, plus a deduction of 50 percent GILTI. This section 250 deduction could effectively reduce the U.S. corporate tax rate on royalties and licensing fees from foreign customers from 21 percent to less than 14 percent. For tax years that begin after December 31, 2025, the deduction amounts are reduced.
- Base erosion anti-abuse tax (“BEAT”): The U.S. is switching to a territorial system with base erosion rules. BEAT may be viewed as similar to a minimum tax for multinationals.
- Indirect foreign tax credits: With the change to a territorial system, these credits under section 902 have been eliminated. However, section 960 indirect foreign tax credits with respect to subpart F income pickup still remain.
Next Action Steps
As you can see from the amount of content in this “quick guide,” the amount of new and modified provisions in the new tax law could be substantial, depending on your and your organization’s unique situation.
