Strategy, Legal & Operations
Tax Cuts & Jobs Act: How to navigate the new tax reform as a business owner
This is part two of a three-part series outlining the critical changes impacting small and medium-sized businesses as a result of new tax legislation. Part one of this series focused on the generalities, concepts, and key new provisions from a macro perspective. This post focuses on business implications. Part three will examine the impacts to individuals, their families, and their estates.
Shareholders and business owners should be pleased with the benefits of our recent tax reform changes that came into play from the Tax Cut & Jobs Act that was signed into law this past December. This is sweeping legislation and while the law is still fresh, readers should prepare for changes, modifications, and ultimately extensive regulations and interpretations from the Internal Revenue Service. Accordingly, all business owners, managers, and principals should remain active as we all navigate our undulating tax environment.
Tax reform implications for business owners
Each business owner should confirm that their business is optimized to maximize owner cash flows, dividends, and ultimate future value. Under the previous rules, federal corporate tax rates were 35% and are now 21%. This applies to all regular corporations. Highly leveraged companies are advised to consider restructuring their debts as limitations on interest expenses are now included. While the Act applies this limitation to entities exceeding $25 million in annual revenues, it is an easy legislative shift to apply this limitation to all companies. Deductible interest will be limited to 30% of taxable income. This limitation does not apply to real estate activities.
Contractors and similar businesses that have found themselves captured in the AMT (Alternative Minimum Tax) trap, you will appreciate its repeal. Previous AMT credits will be recaptured through 2020 based upon allowable formulas. Of course, no good deed goes unpunished. Of note, businesses lose all entertainment related deductions and some of the already limited deductions for meals. Accordingly, the effective cost of attracting new customers and servicing current ones has just increased. How these changes impact your business, of course, will differ based on your habits and interests. Regardless, proper record keeping is more important as it is clear that future audits and examinations will focus on expenses that are of combined nature and lack of documentation will prove costly in the form of audit adjustments.
Startups and cyclical businesses are impacted as current year operating losses will no longer be allowed to be carried back to prior years providing relief and cash flow from previously paid taxes. Carryforwards of business loss tax deductions are still allowed.
Tax reform benefits for small and medium-sized businesses
The Act provides for increases in direct expensing under Section 179 has increased to $1M with a new threshold overall limitation on applicable purchases of $2.5M and bonus depreciation opportunities have expanded. This provides improved alignment with expenditures and their associated deductions. Of course, leverage will still have impacts as future payments may not provide new deductions. For non-leveraged purchases, these benefits clearly align better. These improved deductions and expensing options should stimulate purchases of equipment and this clearly aligns with the Administration’s and Congressional view that increased manufacturing is a net economic positive.
One additional benefit of the new depreciation rules allow used purchases to qualify. Finally, these depreciation benefits are reduced beginning in 2023 and are allowed for purchases subsequent to September 27, 2017.
Accordingly, consulting with your tax advisor about late 2017 purchases will be prudent and beneficial while long-term asset acquisition planning will become more important as we move a few years forward.
Significant changes for global taxpayers and multinational companies
From an outsider’s perspective, a major purpose of this legislation was to force repatriation of foreign earnings of USA based multinationals (think Google, Apple, Starbucks, Amazon, etc.) as there is a requirement to pay tax on all previously deferred foreign earnings over an eight-year period. That corporate tax rate will be 15%.
In exchange for this forced repatriation, corporations will enjoy a modified territorial tax system where foreign earnings are no longer fully incorporated into domestic tax filings. There are also requirements associated with a minimum tax on intangibles, licenses, royalties, and similar income earned in low tax jurisdiction, however, the future repatriation of foreign earnings into domestic C Corporations will be tax-free. Taxes will be paid by shareholders upon future dividend distribution however with proper planning global earnings will benefit domestic cash flows and balance sheets.
While the Act favors regular C Corporations, there are plenty of benefits for pass-through entities including partnerships, LLCs, and S-Corporations. The majority of family businesses fit these historically effective single taxing style of business where corporate level taxation was bypassed. The Act provides a 20% reduction of qualifying taxable income prior to impacting the individual shareholders.
Of course, like all tax legislation, it is never that easy.
There are restrictions and limitations especially for those in the professions including law, accountancy, medicine, and a catchall that includes any business where your personal reputation is significant to your business model.
While most professions are limited in their ability to reduce their direct taxes, architects and engineers were specifically exempt as part of a series of benefits for real estate based businesses. For real estate related businesses including developers, there is a lot to like about like about the Act. Most notably is the faster depreciation and the ability utilize bonus depreciation and expensing options.
The tax act began as a 429-page document. Its overall length, added new concepts, removed or significantly modified old ones, and created additional special industry exceptions. This complexity requires all business owners to remain diligent to changes, especially to the anticipated regulatory guidance.
Your tax advisor along with your own diligence will help you navigate your tax obligations, confirm that you pay the least allowable net tax, and ultimately retain more of what you make.
For more information on these tax changes, tune into my recent interview on the Sage Thought Leadership Podcast with Ed Kless.
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Don't miss important deadlines - and ensure you use the correct forms with this calendar showing key dates in the general tax, employer's tax, and excise tax year for 2021.
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