With the signing into law of the Tax Cuts and Jobs Act (the Act), Congress has enacted the biggest tax reform law in thirty years, one that will make fundamental changes in the taxation of businesses. Most of the business changes take effect for tax years that begin after Dec. 31, 2017, but some of the changes take effect for transactions that take place after Dec. 31, 2017, and others have specialized effective dates. Here are moves that many of your clients should consider making very soon and others that your clients should make efforts to postpone until next year; in each case, we indicate the necessary timing of the move.
The “normal” moves to push income into next tax year and deductions into this year. In general, it tends to be advantageous to push income into a future tax year and deductions into this year, due to the time value of money. And, there are tried and true ways of accomplishing that goal, some of which—like not sending out bills until next year or not aggressively collecting receivables—are dependent on whether the business uses the cash method of accounting. Other such moves include purchasing equipment before the end of the year to take advantage of expensing or cost recovery rules.
New, additional incentives to push income into next tax year and deductions into this year. Here are some additional incentives, beyond the time value of money, that make pushing income into next tax year and deductions into this year even more of a goal that it normally is. (But note that, as a result of other factors, some of which are discussed in later sections of this article, pushing income into next year and deductions into this year may not be good strategy for some taxpayers.)
…Reduction in corporate income tax rate. For tax years that begin after Dec. 31, 2017, the corporate tax rate, which had been at graduated rates as high as 35%, is reduced to a flat 21% rate. Not only does this encourage pushing income into the new year, but it also should cause you to think about converting non–C corporation clients into C corporations, particularly those clients that do not qualify for the new deduction for pass-through income, discussed below. But note that, for corporations that are not personal service corporations and whose taxable income is less than $50,000, their marginal tax rate under the new law is higher than it was previously, so they generally would be better off pushing income into this year until they reach $50,000 of current year taxable income.
…Deduction for pass-through income. For tax years that begin after Dec. 31, 2017, pass-through businesses, e.g., sole proprietorships, partnerships, limited liability companies and S corporations, may be able to take a deduction of up to 20% of their business income. So, in most cases, this deduction will create an incentive to push income into the new tax year and expenses into the current year.
But this new provision is complicated. For example, “specified service trades or businesses,” e.g., businesses that involve performance of services in the fields of health, law, consulting, athletics, financial services and brokerage services, don’t fully qualify unless the taxpayer’s taxable income is equal to or below $157,500 ($315,000 for married individuals filing jointly) and don’t qualify at all if the taxpayer’s taxable income is above $207,500 ($415,000 for married individuals filing jointly). As a result, taxpayers who are in those businesses will not want to push income into the new year if doing so will cause taxable income to exceed the above dollar amounts.
Taxpayers in specified service businesses whose taxable income is too high to qualify for the new deduction should consider incorporating and/or changing/expanding their business model so that they are not specified service trades or businesses. Note that the term “specified service trade or business” is defined in terms of already-existing Code Sec. 1202(e)(3)(A) , so there is existing guidance on what is and what isn’t a specified service trade or business.
…Disallowance of deduction for entertainment expenses. Amounts incurred or paid after Dec. 31, 2017 for entertainment will not be deductible, except for certain meals which may be 50% deductible. Taxpayers should try to pay for any already-incurred expenses during the last days of December. And, to the extent practical, they may wish to incur expenses, e.g., buy tickets to events, and pay for those newly incurred expenses, during the last days of December.
…Disallowance of employer deduction for employee transportation fringe benefits. Amounts incurred or paid after Dec. 31, 2017 for employee transportation fringe benefits, e.g., parking and mass transit, will not be deductible. Try to pay for any such already-incurred expenses, e.g., by reimbursing employees, during the last days of December.
…Modification of the limit on excessive employee compensation. 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 pre-Act 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 limitation for commissions and performance-based compensation are repealed.
So, taxpayers that are affected by these changes should: 1) to the extent practical, pay the types of compensation that were covered by an exception under the old rule but which no longer will be excepted, before the beginning of their new year; 2) reconsider their compensation policies for the new year and thereafter.
…Changes to net operating loss deduction rules. For net operating losses (NOLs) arising in tax years ending after Dec. 31, 2017, the current-law two-year carryback is, in almost all cases, repealed. As a result, increasing a current year NOL has a greater value, since creating such an increase will not only increase the client’s refund from a carryback but also will be the client’s last chance to get a carryback at all for the increased loss.
For losses arising in tax years that begin after Dec. 31, 2017, the NOL deduction is limited to 80% of taxable income. NOLs incurred this year are not subject to this rule. So, it can be advantageous for a taxpayer with current year and future year losses to push deductions into the current tax year and push income into next year.
Other year end planning moves. Here are some other year-end planning moves that can save taxes whether or not your client is interested in deferring income.
…Expensing and depreciation. In general, taxpayers will want to accelerate the purchase of depreciable assets to take advantage of the 100% bonus depreciation provision included in the Act for property placed in service after Sept. 27, 2017. Also note that, under the Act, used property qualifies for bonus depreciation. Accelerating the purchase of qualifying property will offset income taxable at the 2017 higher tax rates.
On the other hand, because limitations on automobile depreciation are greatly increased for automobiles placed in service after Dec. 31, 2017, many taxpayers will benefit from postponing the purchase of automobiles until 2018.
…Like-kind exchanges. Generally effective for transfers after Dec. 31, 2017, Code Sec. 1031 like-kind exchanges are limited to transfers of real property not held primarily for sale. However, under a transition rule, the crackdown doesn’t apply to exchanges of personal property if the taxpayer either disposed of the relinquished property or acquired the replacement property on or before Dec. 31, 2017. If a client can perform either of those actions before Dec. 31 with respect to personal property, he will be able to benefit from the like-kind exchange rules.
…Alternative minimum tax. For tax years that begin after Dec. 31, 2017, the corporate alternative minimum tax (AMT) is repealed. Therefore, corporations that would be subject to the AMT for a year before the repeal are likely to benefit by postponing transactions that result in AMT preferences or adjustments, and/or by not making elections that result in AMT preferences or adjustments, in that year.
…Repeal of domestic production activities deduction. For tax years that begin after Dec. 31, 2017, the domestic production activities deduction (DPAD) is repealed. DPAD is a deduction equal to 9% (6% in the case of certain oil and gas activities) of the lesser of the taxpayer’s qualified production activities income or the taxpayer’s taxable income for the tax year. Entities that are not C corporations, and that have income that would both increase their current year DPAD if it were recognized this tax year and would not increase their deduction for pass-through income (as described at “Deduction for pass-through income” above) if it were recognized in a future year, will likely benefit by recognizing that income in this tax year.
…Liberalization of the long-term contract rules. Under current law, construction companies with average annual gross receipts $10 million or less, that meet certain other requirements, may use the more favorable completed contract method for recognizing income, rather than the less favorable percentage-of-completion method. For contracts entered into after Dec. 31, 2017, that $10 million figure is increased to $25 million. For construction companies whose average annual gross receipts are greater than $10 million and less than or equal to $25 million, it will in most cases be advantageous to postpone entering into a contract until after Dec. 31.
…Limit on deduction of business interest. For tax years that begin 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 amount of any business interest not allowed as a deduction for any taxable year is treated as business interest paid or recruited in the succeeding tax year. This new rule does not apply to businesses with average annual gross receipts that do not exceed $25 million. And there are other exceptions as well.
Consider whether you have clients that are likely to be affected by this provision, and what they can do about it. Possible steps would be restructuring the financing of the entity or liquidation of assets to raise capital.