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Tax Reform

How Have Business Taxes Changed in the Last Two Years?

by
Lee Reams, BSME, EA
on
3/28/2019
How Have Business Taxes Changed in the Last Two Years?

The sheer volume of changes tax professionals have had to familiarize themselves with over the last 24 months has been far higher than any in the industry could have predicted. There are pieces of the 2017 Tax Cuts and Jobs Act (TCJA) – such as the Section 199A deduction – that are still creating mass confusion among tax professionals and taxpayers alike.

So, what are some of the biggest ways business taxes have changed over the past two years? Below we’ll discuss a few key areas to be aware of.

199A Flow-Through Deduction

As part of the Act, Congress changed the tax-rate structure for C-corporations to a flat rate of 21% instead of the former graduated rates that topped out at 35%. Needing a way to equalize the rate reduction for all taxpayers with business income, Congress came up with a new deduction for businesses that are not organized as C-corporations.

As a result, tax reform provides a substantial tax benefit for most non-C- corporation business owners in the form of a deduction (referred to as the Sec 199A deduction) that is equal to 20% of their qualified business income (QBI). QBI is generally the net income or loss with respect to businesses that are conducted in the U.S.

However, as with all things tax, it is far from a simple 20% of QBI. In fact, this deduction has been referred to as “passive loss rules on steroids.” It has a number of limitations and qualifications that make it difficult to understand by professionals much less laypersons. Most of these limitations are based upon the business owner’s personal 1040 taxable income not the businesses taxable income. In addition, it applies one set of rules for specified service trades and businesses (SSTBs) and another for qualified trades businesses (QTBs). Tax reform singles out attorneys, accountants, performing artists, athletes, financial services, brokers (except real estate and insurance) and certain others as SSTBs. Once the SSTB owner’s 1040 taxable income for 2019 exceeds $321,400 on a joint return ($160,700 for others), the deduction begins to phase out. Once it reaches $421,400 ($210,700), the 199A deduction is fully phased out.

For QTBs those same thresholds apply except instead of phasing out the deduction the “wage limit” is phased in, so that the 199A deduction is the lesser of 20% of QBI or the wage limit. The wage limit is a computation that uses the wages paid by the business and the cost of certain business assets owned and being used by the company.

On top of that there are special rules for dealing with business entities with losses, and aggregating businesses. Plus, the issue of wages brings to the forefront the complex issue of determining reasonable compensation for working S corporation stockholders.

Bonus Depreciation

The addition of 100% depreciation gives a business the option of writing off the expenses of business purchases of most tangible business property except structures, including qualified improvement property. Qualified improvement property means “any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was first placed in service,” except certain expenditures attributable to the enlargement of the building, such as elevators, escalators, and the internal structural framework of the building do not qualify.

Sec 179 Expensing

Section 179 is the code section that allows purchases of business property to be expensed. The amount that can be expensed under this provision was increased from $510,000 in 2017 to $1,020,000 per year for 2019 and the definition of property eligible for Sec 179 expensing was expanded to include beds, furniture, refrigerators, ranges, and other equipment, used in the living quarters of a lodging facility such as an apartment house. This previously was only allowed for transient housing such as hotels and motels. Another new definition applies Sec 179 to improvements to nonresidential real property after such property was first placed in service and includes roofs, heating and air-conditioning, fire protection and security systems.

Vehicle Write-Offs

For passenger autos placed in service during 2018 the maximum amount of allowable depreciation is increased to the following amounts if bonus depreciation is not claimed: $10,000 (up from $3,160 in 2017) for the placed-in-service year, $16,000 (up from $5.100 in 2017) for the 2nd year, $9,600 (up from $3,050 in 2917) for the 3rd year, and $5,760 (up from $1,875 in 2017) for the 4th and later years. Amounts are indexed for inflation after 2018. The first-year limitation may be increased by the $8,000 bonus depreciation, meaning in the first year the deduction could be as much as $18,000. To obtain the maximum amounts a vehicle would have to cost $58,000 or more.

Business Entertainment

No deduction is allowed for (1) an activity generally considered to be entertainment, amusement or recreation, (2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes, or (3) a facility or portion thereof used in connection with items (1) and (2). This also disallows a deduction for expenses associated with providing any qualified transportation fringe to the taxpayer’s employees. Employers may still deduct 50% of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel) and business meals with clients and prospective clients so long as the business owner or employee is present, and the meal is not lavish or extravagant.

Net Operating Loss (NOL)

The 2-year carryback provision is generally repealed for NOLs occurring after 2017 except for certain farm losses. For NOLs occurring after 2017, the NOL deduction can generally only offset 80% (down from 100% under prior law) of a taxpayer’s taxable income (determined without regard to NOL deduction for the year). In addition, any unused NOL is carried forward indefinitely (prior law limited the carryover to 20 years). For small businesses, losing the 2-year carryback eliminates the ability to get an immediate tax refund and cash infusion for the taxpayer.

Excess Business Losses for Individuals

This is a new limitation added by TCJA for small businesses which replaces a similar limit that was previously only applied to farm losses. A taxpayer other than a C corporation is not allowed an “excess business loss.” Instead, the loss would be carried forward and treated as part of the taxpayer’s net operating loss (NOL) carryforward in subsequent taxable years.  Excess business loss for a taxable year is defined in the Act as the excess of the taxpayer’s aggregate deductions attributable to the taxpayer’s trades or businesses for that year, over the sum of the taxpayer’s aggregate gross income or gain for the year plus a “threshold amount” of $500,000 for married individuals filing jointly, or $250,000 for other individuals. The provision will apply after taking into account the passive activity loss rules.

Example: A single taxpayer has a Schedule C (self-employment) loss of $280,000 and no other trade or business income for 2019. That results in an excess loss amount of $30,000 (<280,000> - 250,000). The Schedule C loss is reported as normal and the excess is added back in as other income on the tax return and the $30,000 is added to or treated as a post-2017 NOL carryover.

Other changes include a cash method of accounting for certain small businesses allowing inventory to be treated as non-incidental materials and supplies.

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As tax pros continue working through this busy tax season, areas like the ones we discussed (and many more) will continue to be major considerations—and points of confusion—for much of the industry.

To stay up-to-date on key topics such as these, keep checking back for more from the TaxBuzz blog, or subscribe to receive email updates here(LINK).

Questions? Feel free to ask them in the comments below or Tweet us.

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Lee Reams, BSME, EA

Lee Reams, BSME, EA

Editor-in-Chief

Besides his role at CountingWorks as an educator and speaker to thousands of accountants nationwide, Lee manages a technical research service for a large group of tax accountants which sharpens his technical skills. Lee served on the Board of Blackline Systems, is a former Board of Director for the California Tax Education Council, is a Past President of the San Fernando Valley Chapter of Enrolled Agents, Member and Past Director for the California Society of Enrolled Agents.

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