Navigating Tomorrow's Tax Landscape
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The Tax Cuts and Jobs Act (TCJA) signed into law in December 2017 makes significant changes that impact both individuals and businesses. For businesses, it lowers the corporate tax rate to a flat 21% and provides a new 20% deduction for qualified pass-through business income. For individuals, it increases standard deductions, modifies individual tax rates, and places new limits on certain itemized deductions. The TCJA generally aims to simplify the tax code, provide tax relief for the middle class, and make U.S. business taxes more competitive globally.
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Navigating Tomorrow's Tax Landscape
- 1. Tax Cuts and Jobs Act: How It Could Impact You and Your Business Jim Forbes, CPA Chris Sivak, CPA
- 2. 2 Three Principles for Tax Reform 1. Simplifying the personal tax code 2. Providing tax relief to the middle class 3. Giving businesses a competitive tax rate
- 3. 3 Tax Cuts and Jobs Act (TCJA) • Signed into law December 22, 2017. • Generally effective for tax years beginning January 1, 2018 and later. • Reduced C corporation tax rate from graduated rates up to 35% to flat 21% • Provides a new Business Income Deduction of up to 20% for qualifying businesses, lowering pass-through rate to 29.6%. • Reduced individual tax rate from 39.6% to 37%
- 4. 4 Business Rate Changes Corporate tax rate • Flat rate of 21% (effective 1/1/2018) Fiscal year C corporations will use blended rate (Notice 2018-38) Corporate Alternative Minimum Tax (AMT) • Repealed • AMT credits refundable from 2018 through 2021 and can offset regular tax liability.
- 5. 5 Net Operating Losses (NOL) • NOLs limited to 80% of taxable income for tax periods after 12/31/2017 • Pre-2018 NOLs are not subject to limitation • No carryback except for certain losses incurred in trade or business of farming • Can be carried forward indefinitely
- 6. 6 Business Expensing Bonus Depreciation: • A 100% first-year deduction for the adjusted basis is allowed for qualified property placed in service after 9/27/2017 and before 1/1/2023. • Allowed for both new and used property. • The first-year bonus depreciation deduction phases down to 80%, 60%, 40% and 20% for property placed in service in 2023, 2024, 2025 and 2026 respectively.
- 7. 7 Interest Expense Cap on net business interest expense (every business, regardless of form) • Limited to 30% of “adjusted taxable income” • Adjusted taxable income = taxable income without regard to: Net interest expense NOLs Depreciation, amortization and depletion (eliminated for years after 1/1/2022) • Unused expense carried forward indefinitely • Businesses with less than $25M average annual gross receipts exempt
- 8. 8 Meals and Entertainment Transitional guidance provided in Notice 2018-76 Entertainment • Theaters, clubs, lounges and sporting events nondeductible. Meals • Generally still subject to 50% limitation. • Recreational activities primarily for the benefit of employees (holiday party, company picnic) still 100% deductible.
- 9. 9 Pass-Through Income (Sec 199A) S corporations, Partnerships or Sole proprietorships: • New deduction for pass-through income (Deduction for “domestic qualified business income”) • Deduction of 20% of domestic qualified business income (QBI); subject to limitation, expires 12/31/2025. • QBI is defined as the net amount of qualified items of income, gain, deduction and loss with respect to trade or business. • The deduction reduces taxable income, rather than adjusted gross income.
- 10. 10 Pass-Through Income Limitations: • Taxpayers over “Threshold” amount: $157,500 for single filers ($315,000 married filing joint) • The deduction cannot exceed the greater of: 50% of the W-2 wages with respect to the qualified trade or business, or… The sum of 25% of the W-2 wages plus 2.5% of the unadjusted basis of all qualified property.
- 11. 11 Qualified Trade or Business • Service businesses disqualified from deduction. Health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing and investment management or any trade or business where the principal asset is the reputation or skill of one or more of its employee owners. • Architects and engineers are exceptions and do qualify for the deduction.
- 12. 12 Proposed 199A Regulations • Issued August 8 • Government requested comments and scheduled a public hearing October 18, 2018. • Generally taxpayer-friendly. • Service or property provided to SSTB (1.199A-5(c)(2)) • Allowed (but not required) to aggregate businesses (1.199A-4) • Clarifies wages paid to PEO qualify as W-2 wages. (1.199A- 2(b)(2)(ii))
- 13. 13 Pass-Through Income - Example 1 • Taxable income of $1M • Assume W-2 wages of $20M • 50% of W-2 wages = $10M • QBI deduction = 20% of $1M ($200K) • Tax 37% x ($1M - $200K) = $296,000 • Effective rate = 29.6%
- 14. 14 Pass-Through Income – Example 2 • Taxable income of $20M • Assume W-2 wages of $1M • 50% of W-2 wages = $500K • QBI deduction = lesser 20% of $20M ($4M) or 50% of W-2 wages ($500K) • Tax 37% x ($20M - $500K) = $7,215,000 • Effective rate = 36.08%
- 15. 15 Pass-Through Income Certain types of Income excluded from QBI: • Capital gains or losses • Dividends • Interest income (unless interest is properly allocable to the business) • Employee compensation • Guaranteed payments to a partner
- 16. 16 Accounting Methods Expanded use of cash method of accounting • Businesses with gross receipts of $25M or less permitted to use cash method. Includes those that have inventory. UNICAP • Businesses with gross receipts of $25M or less are exempt. Long-term contracts • Businesses with gross receipts of $25M or less can use completed contract method.
- 17. 17 Individual Rate Changes Individual rate reduction and brackets (rates sunset at the end of 2025) • 10%, 12%, 22%, 24%, 32%, 35% and 37% Highest rate applies at $500,001 for single and HOH, $600,001 for married filing jointly and surviving spouses. Kiddie Tax modified • Earned income is taxed under the rates for single individuals. • Net unearned income is taxed according to the brackets applicable to trusts and estates.
- 18. 18 ACA Individual Mandate • Repealed. Individuals shared responsibility payment reduced to zero for months beginning after 12/31/2018
- 19. 19 Itemized Deductions State and Local taxes (SALT) • Deduction limited to $10,000 for the aggregate of 1) State & local real and personal property taxes and 2) State & local income tax (or state & local sales tax paid, if higher). Mortgage Interest • Deduction for mortgage interest paid or incurred capped at $750,000 (MFJ) or $375,000 (MFS) of acquisition indebtedness for tax years 2018 to 2025. • New lower limit doesn’t apply to acquisition indebtedness incurred before 12/15/2017. • Deduction for interest on home equity indebtedness is suspended until 12/31/2025.
- 20. 20 Mortgage Interest Examples • Joe takes out a home equity line to pay for his son’s college tuition. The loan is secured on his main residence. Does this qualify for deduction? No, the proceeds were not used to buy, build, or substantially improve his home. • Suzy has a mortgage of $365,000 on her main home and takes out a mortgage of $250,000 to buy a vacation home. Can Suzy deduct the interest? Yes, because the total amount of the two mortgages would be under the $750,000 threshold. • Same facts as the last example, but instead of a mortgage, Suzy takes out a home equity line on her current home. Would that qualify? No, because the proceeds weren’t used to buy, build or substantially improve her home.
- 21. 21 Itemized Deductions Medical Expenses Threshold • Retains the deduction and the 10% of AGI limitation is reduced to 7.5% for 2017 and 2018. Charitable Donations • Deduction for cash contributions modified to increase AGI limitation to 60% for 2018-2025. • The donee-reporting exemption from the contemporaneous written acknowledgment requirement is repealed. • No deduction for amounts paid for college athletic seating rights.
- 22. 22 Itemized Deductions • Deductions Suspended (2018-2025) Personal casualty and theft losses (except for losses incurred in a federally-declared disaster) Moving expenses (except for members of Armed Forces on active duty pursuant to military order and on permanent change of station) “Pease” limitation Tax preparation fees, unreimbursed business expenses and other miscellaneous itemized deductions that are subject to the 2% floor • Deductions for living expenses of members of Congress eliminated • Combat zone treatment extended to Egypt’s Sinai Peninsula
- 23. 23 Standard Deduction and Exemption Standard deduction increased • $12,000 for single filers • $18,000 for head of household filers • $ 24,000 for married filing joint Personal exemptions suspended
- 24. 24 Standard Deduction and Exemption Is the increased standard deduction more beneficial? Old Law New Law Old Law New Law Old Law New Law
- 25. 25 Child Tax Credit • Increased to $2,000 ($1,400 refundable per qualifying child) • Phaseout limits begin at $200,000 for single filers and $400,000 for MFJ • $500 nonrefundable credit provided for non-child dependents • Earned income threshold for refundable portion of the credit decreased from $3,000 to $2,500
- 26. 26 Individual AMT Alternative Minimum Tax (AMT) retained with higher exemption amounts • $109,400 for joint returns & surviving spouses ( $1M phaseout amount) • $70,300 for single filers ($500K phaseout amount) • $22,500 for trust and estates ($75K phaseout amount)
- 27. 27 Comprehensive Example 1 • You have a married couple with $250,000 of W2 income, own their house, make no charitable donations and have no kids. What would their return look like in 2018 compared to 2017? 2017 2018 Diff Income $250,000 $250,000 - Exemptions ($8,100) - ($8,100) Standard Deduction ($12,700) ($24,000) $11,300 Taxable Income $229,200 $226,000 ($3,200) Tax $51,060 $42,820 ($8,240)
- 28. 28 Comprehensive Example 2 • You have a married couple with $250,000 of W2 income, paid mortgage interest of $6,500, real estate tax of $3,500, state and local income tax of $20,000, $10,000 of charitable donations and have two kids. What would their return look like in 2018 compared to 2017?
- 32. 32 Contact Information 32 Christopher G. Sivak, CPA Partner csivak@skodaminotti.com 330-576-1832 Jimmy A. Forbes, CPA Partner jforbes@skodaminotti.com 440-605-7156
Editor's Notes
- Preface this slide with what has happened since the Fedex case
- Preface this slide with what has happened since the Fedex case
- Note that this provision, absent future action, will expire at the end of 2025 while the C corporation rate reduction is “permanent”.
- Generally, the 2.5% of unadjusted basis of all qualified property will apply for a real estate partnership.
- Note the last category is very vague and subject to interpretation. It’s a catch-all for any other service business not specifically listed.
- Anti-abuse – To prevent an accounting firm from separating its business to take advantage of the 20% deduction. 1.199A-5(c)(2) 2) Services or property provided to an SSTB— (i) In general. An SSTB includes any trade or business that provides 80 percent or more of its property or services to an SSTB if there is 50 percent or more common ownership of the trades or businesses. (ii) Less than substantially all of property or services provided. If a trade or business provides less than 80 percent of its property or services to an SSTB within the meaning of this section and there is 50 percent or more common ownership of the trades or businesses, that portion of the trade or business of providing property or services to the 50 percent or more commonly-owned SSTB is treated as a part of the SSTB. (iii) 50 percent or more common ownership. For purposes of paragraphs (c)(2)(i) and (ii) of this section, 50 percent or more common ownership includes direct or indirect ownership by related parties within the meaning of sections 267(b) or 707(b). (iv) Example. Law Firm is a partnership that provides legal services to clients, owns its own office building and employs its own administrative staff. Law Firm divides into three partnerships. Partnership 1 performs legal services to clients. Partnership 2 owns the office building and rents the entire building to Partnership 1. Partnership 3 employs the administrative staff and through a contract with Partnership 1 provides administrative services to Partnership 1 in exchange for fees. All three of the partnerships are owned by the same people (the original owners of Law Firm). Because there is 50% or more common ownership of each of the three partnerships, Partnership 2 provides substantially all of its property to Partnership 1, and Partnership 3 provides substantially all of its services to Partnership 1, Partnerships 1, 2, and 3 will be treated as one SSTB under paragraph (a)(6) of this section. Aggregation – assume taxpayer has two profitable businesses, one with high profits and low wages. The other has low profits and high wages. (b) Aggregation rules— (1) General rule. Except as provided in paragraph (b)(3) of this section, trades or businesses may be aggregated only if an individual can demonstrate that-- (i) The same person or group of persons, directly or indirectly, owns 50 percent or more of each trade or business to be aggregated, meaning in the case of such trades or businesses owned by an S corporation, 50 percent or more of the issued and outstanding shares of the corporation, or, in the case of such trades or businesses owned by a partnership, 50 percent or more of the capital or profits in the partnership; (ii) The ownership described in paragraph (b)(1)(i) of this section exists for a majority of the taxable year in which the items attributable to each trade or business to be aggregated are included in income; (iii) All of the items attributable to each trade or business to be aggregated are reported on returns with the same taxable year, not taking into account short taxable years; (iv) None of the trades or businesses to be aggregated is a specified service trade or business (SSTB) as defined in §1.199A-5; and (v) The trades or businesses to be aggregated satisfy at least two of the following factors (based on all of the facts and circumstances): (A) The trades or businesses provide products and services that are the same or customarily offered together. (B) The trades or businesses share facilities or share significant centralized business elements, such as personnel, accounting, legal, manufacturing, purchasing, human resources, or information technology resources. (C) The trades or businesses are operated in coordination with, or reliance upon, one or more of the businesses in the aggregated group (for example, supply chain interdependencies).
- Now W-2 taxed at 40.8% (37% regular tax, 1.45% medicare tax times two plus 0.9% additional medicare tax), flow-through earnings taxed at 29.6%. Now differential is over 11%.
- The brackets will be adjusted for inflation beginning 2018, but instead of the standard Consumer Price Index being used to determine inflation they will use a chained CPI; The chained CPI has a tendency to increase at a slower rate than the standard due to consumers reacting to price increases.
- One other item that they are no longer allowing is the deduction for alimony payments
- One other item that they are no longer allowing is the deduction for alimony payments
- Currently a portion of the child tax credit is refundable; now up to $1,000 would increase the amount that is eligible to be refunded to $1,000 adjusted for inflation annually. You would need to include the dependents SSN in order to claim the refundable portion of the credit.