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US Tax Reform

2017 Tax Reform: Game-changing tax overhaul in effect for businesses in 2018

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

The new tax year is a true game-changer for taxpayers and their advisers, as many fundamental, decades-old tax rules have been repealed or suspended, with many new ones going into effect. This article highlights the tax changes that apply in 2018 to businesses. All changes relate to the Tax Cuts and Jobs Act unless otherwise indicated. Changes related to pass-throughs will be covered in a future article.

For more details on tax changes affecting individuals in effect in 2018, see Weekly Alert ¶  13  1/11/2018 (tax rates, deductions, and credits) and Weekly Alert ¶  45  1/11/2018 (deferred compensation, tax-preferred accounts, retirement plans, estate and gift taxes, capital assets and investments, and disaster losses). For more details on the Tax Cuts and Jobs Act, see Thomson Reuters Checkpoint Special Study: Highlights of the Tax Cuts and Jobs Act, which can be accessed on Checkpoint by clicking on the Table of Contents tab on the tool bar, and then following the link for “2017 Tax Reform.”

Corporate tax rate reduced. For tax years beginning after Dec. 31, 2017, the corporate tax rate is a flat 21% rate. (Code Sec. 11(b))

Dividends received deduction percentages reduced. For tax years beginning after Dec. 31, 2017, the 80% dividends received deduction is reduced to 65%, and the 70% dividends received deduction is reduced to 50%. (Code Sec. 243)

AMT repealed. For tax years beginning after Dec. 31, 2017, the corporate AMT is repealed. (Code Sec. 55) For tax years beginning after 2017 and before 2022, the AMT credit is refundable in an amount equal to 50% (100% for tax years beginning in 2021) of the excess of the minimum tax credit for the tax year over the amount of the credit allowable for the year against regular tax liability.

Expensing rules liberalized. For property placed in service in tax years beginning after Dec. 31, 2017, the maximum amount a taxpayer may expense under Code Sec. 179 is increased to $1 million, and the phase-out threshold amount is increased to $2.5 million.

Property eligible for expensing is expanded.For property placed in service in tax years beginning after Dec. 31, 2017, the definition of Code Sec. 179 property is expanded to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging. The definition of qualified real property eligible for Code Sec. 179 expensing also is expanded to include the following improvements to nonresidential real property after the date such property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems. (Code Sec. 179)

Increased luxury auto dollar limits. For passenger automobiles placed in service after Dec. 31, 2017, in tax years ending after that date, for which the additional first-year depreciation deduction under Code Sec. 168(k) is not claimed, the maximum amount of annual allowable depreciation/expensing deduction is increased to: $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years in the recovery period. For passengers autos eligible for bonus first-year depreciation, the maximum first-year depreciation allowance remains at $8,000. (Code Sec. 280F) In addition, computer or peripheral equipment is removed from the definition of listed property and so isn’t subject to the heightened substantiation requirements that apply to listed property. (Code Sec. 280F)

15-year writeoff for qualified improvement property. For property placed in service after Dec. 31, 2017, the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property eligible for a 15-year writeoff, are replaced with new category called qualified improvement property, which is depreciated over 15-years via straight line (or 20 years via the Alternative Depreciation System (ADS)). Qualified improvement property is any improvement to an interior portion of a building that is nonresidential real property if the improvement is placed in service after the date the building was first placed in service, except for any improvement for which the expenditure is attributable to (1) enlargement of the building, (2) any elevator or escalator, or (3) the internal structural framework of the building. (Code Sec. 168(e)(6))

Shortened ADS recovery period for residential realty. For property placed in service after Dec. 31, 2017, the ADS recovery period for residential rental property is shortened from 40 years to 30 years. (Code Sec. 168)

Shortened recovery period for farming equipment. For property placed in service after Dec. 31, 2017, in tax years ending after that date, the cost recovery period is shortened from seven to five years for any machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) used in a farming business, the original use of which commences with the taxpayer. (Code Sec. 168(e))

In addition, the required use of 150% declining balance depreciation for property used in a farming business (i.e., for 3-, 5-, 7-, and 10-year property) is repealed. The 150% declining balance method continues to apply to any 15-year or 20-year property used in the farming business to which the straight-line method does not apply, and to property for which the taxpayer elects the use of the 150% declining balance method. (Code Sec. 168(b))

ADS use for certain farm assets. For tax years beginning after Dec. 31, 2017, an electing farming business—i.e., a farming business electing out of the new Code Sec. 163(j) limitation on the deduction for interest (discussed below)—must use ADS to depreciate any property with a recovery period of 10 years or more (e.g., a single purpose agricultural or horticultural structure, trees or vines bearing fruit or nuts, farm buildings, and certain land improvements). (Code Sec. 168)

More taxpayers eligible to deduct costs of replanting citrus plants lost due to casualty. The uniform capitalization rules of Code Sec. 263A don’t apply to certain agricultural producers and co-owners; instead, they can deduct costs incurred in replanting edible crops for human consumption following loss or damage due to freezing temperatures, disease, drought, pests, or casualty. For replanting costs paid or incurred after Dec. 22, 2017, but not after Dec. 22, 2027, for citrus plants lost or damaged due to casualty, the definition of taxpayers eligible to deduct such costs is expanded to include a person other than the taxpayer if (1) the taxpayer has an equity interest of not less than 50% in the replanted citrus plants at all times during the tax year in which the replanting costs are paid or incurred and such other person holds any part of the remaining equity interest, or (2) such other person acquires all of the taxpayer’s equity interest in the land on which the lost or damaged citrus plants were located at the time of such loss or damage, and the replanting is on such land. (Code Sec. 263A(d))

Tax on medical devices goes into effect. For sales after Dec. 31, 2017, a tax equal to 2.3% of the sale price is imposed on the sale of any taxable medical device by the manufacturer, producer, or importer of such device. (Code Sec. 4191(a)Code Sec. 4191(c) ) A taxable medical device is any device defined in §201(h) of the Federal Food, Drug, and Cosmetic Act (FFDCA) that’s intended for humans. A “device” is an instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article. There’s a retail exemption for items such as eyeglasses, contact lenses and hearing aids. The tax was to have gone into effect after 2015, but the “Protecting Americans From Tax Hikes” Act (PATH Act, PL 114-113, 12/18/2015) provided for a 2-year moratorium on the tax.

Limits on deduction for business interest. For tax years beginning after Dec. 31, 2017, every business, regardless of its form, is generally subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income. The net interest expense disallowance is determined at the tax filer level. However, a special rule applies to pass-through entitles, which requires the determination to be made at the entity level (e.g., at the partnership level instead of the partner level). (Code Sec. 163(j))

For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2022, adjusted taxable income of a business is computed without regard to various deductions, including the deductions for depreciation, amortization, or depletion and without the former Code Sec. 199 deduction (which is repealed effective Dec. 31, 2017).

The amount of any business interest not allowed as a deduction for any taxable year is treated as business interest paid or accrued in the succeeding tax year. Business interest may be carried forward indefinitely, subject to certain restrictions applicable to partnerships. (Code Sec. 163(j))

An exemption from these rules applies for taxpayers (other than tax shelters) with average annual gross receipts for the three-tax year period ending with the prior tax year that do not exceed $25 million. The business-interest-limit provision does not apply to certain regulated public utilities and electric cooperatives. Real property trades or businesses can elect out of the provision if they use ADS to depreciate applicable real property used in a trade or business. Farming businesses can also elect out if they use ADS to depreciate any property used in the farming business with a recovery period of ten years or more. An exception from the limitation on the business interest deduction is also provided for floor plan financing (i.e., financing for the acquisition of motor vehicles, boats or farm machinery for sale or lease and secured by such inventory).

Special rules apply to partnerships and to the carryforward of disallowed partnership interest.

NOL deduction modified. For NOLs arising in tax years ending after Dec. 31, 2017, the two-year carryback and the special carryback provisions generally are repealed.

For losses arising in tax years beginning after Dec. 31, 2017, the NOL deduction is limited to 80% of taxable income (determined without regard to the NOL deduction, itself). Carryovers to other years are adjusted to take account of this limitation, and, except as provided below, NOLs can be carried forward indefinitely.

A two-year carryback applies in the case of certain losses incurred in the trade or business of farming. Additionally, NOLs of property and casualty insurance companies can be carried back two years and carried over 20 years to offset 100% of taxable income in such years. (Code Sec. 172)

DPAD repealed. For tax years beginning after Dec. 31, 2017, the domestic production activities deduction (DPAD) is repealed. (Former IRC Sec. 199)

Five-year writeoff of specified R&E expenses. For amounts paid or incurred in tax years beginning after Dec. 31, 2021, “specified R&E expenses” must be capitalized and amortized ratably over a 5-year period (15 years if conducted outside of the U.S.), beginning with the midpoint of the tax year in which the specified R&E expenses were paid or incurred.

Specified R&E expenses subject to capitalization include expenses for software development, but not expenses for land or for depreciable or depletable property used in connection with the research or experimentation (but do include the depreciation and depletion allowances of such property). Also excluded are exploration expenses incurred for ore or other minerals (including oil and gas). In the case of retired, abandoned, or disposed property with respect to which specified R&E expenses are paid or incurred, any remaining basis may not be recovered in the year of retirement, abandonment, or disposal, but instead must continue to be amortized over the remaining amortization period. (Code Sec. 174)

Broadened denial of deduction for fines, penalties, etc.For amounts generally paid or incurred on or after Dec. 22, 2017, no deduction is allowed for any otherwise deductible amount paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government or specified nongovernmental entity in relation to the violation of any law or the investigation or inquiry by such government or entity into the potential violation of any law. Certain exceptions apply. (Code Sec. 162(f))

The above provisions don’t apply to amounts paid or incurred under any binding order or agreement entered into before Dec. 22, 2017. But this exception does not apply to an order or agreement requiring court approval unless the approval was obtained before Dec. 22, 2017.

No deduction for amount paid for sexual harassment subject to nondisclosure agreement. Effective for amounts paid or incurred after Dec. 22, 2017, no deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement. (Code Sec. 162,)

Deduction for local lobbying expenses repealed. For amounts paid or incurred on or after Dec. 22, 2017, the Code Sec. 162(e) deduction for lobbying expenses with respect to legislation before local government bodies (including Indian tribal governments) is eliminated. (Code Sec. 162(e))

Exclusions from contributions to capital. Effective for contributions made after Dec. 22, 2017 (except as otherwise provided below), the term “contributions to capital” for purposes of Code Sec. 118 (contributions to the capital of a corporation) does not include: any contribution in aid of construction or any other contribution as a customer or potential customer, and any contribution by any governmental entity or civic group (other than a contribution made by a shareholder as such). (Code Sec. 118)

The new rule does not apply to any contribution made after Dec. 22, 2017, by a governmental entity pursuant to a master development plan that had been approved before Dec. 22, 2017, by a governmental entity.

Orphan drug credit modified. For amounts paid or incurred after Dec. 31, 2017, the Code Sec. 45C orphan drug credit is limited to 25% (instead of prior law’s 50%) of so much of qualified clinical testing expenses for the tax year. Taxpayers can elect a reduced credit in lieu of reducing otherwise allowable deductions in a manner similar to the research credit under Code Sec. 280C. (Code Sec. 45C)

Rehab credit modified. For amounts paid or incurred after Dec. 31, 2017, the 10% credit for qualified rehabilitation expenditures with respect to a pre-’36 building is repealed, and a 20% credit is provided for qualified rehabilitation expenditures with respect to a certified historic structure; the credit can be claimed ratably over a 5-year period beginning in the tax year in which a qualified rehabilitated structure is placed in service. (Code Sec. 47)

ew credit for employer paid family and medical leave. For wages paid in tax years beginning after Dec. 31, 2017, but not beginning after Dec. 31, 2019, businesses may claim a general business credit equal to 12.5% of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave (FMLA) if the rate of payment is 50% of the wages normally paid to an employee. The credit is increased by 0.25 percentage points (but not above 25%) for each percentage point by which the rate of payment exceeds 50%. To qualify for the credit, all qualifying full-time employees must be given at least two weeks of annual paid family and medical leave (and all less-than-full-time qualifying employees have to be given a commensurate amount of leave on a pro rata basis). (Code Sec. 45S)

Limit on employee compensation deduction. A deduction for compensation paid or accrued with respect to a covered employee of a publicly traded corporation is limited to no more than $1 million per year. However, under prior law, exceptions applied for: (1) commissions; (2) performance-based remuneration, including stock options; (3) payments to a tax-qualified retirement plan; and (4) amounts that are excludable from the executive’s gross income. For tax years beginning after Dec. 31, 2017, the exceptions to the $1 million deduction limit for commissions and performance-based compensation are repealed. The definition of “covered employee” is revised to include the principal executive officer, the principal financial officer, and the three other highest paid officers. If an individual is a covered employee with respect to a corporation for a tax year beginning after Dec. 31, 2016, the individual remains a covered employee for all future years. Transition rules apply to a written binding contract which was in effect on Nov. 2, 2017 (Code Sec. 162(m))

Meal, entertainment and fringe benefit changes. There are five changes to note in this area, all effective for amounts incurred or paid after Dec. 31, 2017:

  • Deductions for business-related entertainment expenses are disallowed.
  • The 50% limit on the deductibility of business meals is expanded to meals provided through an in-house cafeteria or otherwise on the premises of the employer.
  • Deductions for employee transportation fringe benefits (e.g., parking and mass transit) are denied, but the exclusion from income for such benefits received by an employee is retained (except in the case of qualified bicycle commuting reimbursements).
  • No deduction is allowed for transportation expenses that are the equivalent of commuting for employees (e.g., between the employee’s home and the workplace), except as provided for the safety of the employee. However, this bar on deducting transportation expenses doesn’t apply to any qualified bicycle commuting reimbursement, for amounts paid or incurred after Dec. 31, 2017, and before Jan. 1, 2026.
  • For purposes of the employee achievement award rules, “tangible personal property” does not include cash, cash equivalents, gifts cards, gift coupons, gift certificates (other than where the employer pre-selected or pre-approved a limited selection) vacations, meals, lodging, tickets for theatre or sporting events, stock, bonds or similar items. and other non-tangible personal property. (Code Sec. 274)
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