Special Bulletin! What AICC Members Need to Know Now About the New Tax Law!
Tuesday, December 19, 2017
Posted by: Alyce Ryan
Mitch Klingher, CPA, of Klingher Nadler LLP, has authored this special bulletin for AICC members. Read and act NOW to take advantage of its provisions. As part of AICC’s service to the industry, Mitch will conduct a special webinar on Wednesday, December 27, at 2:00 p.m. Eastern. REGISTER FOR THE SPECIAL BULLETIN BROADCAST.
Download the Tax Law Article
The latest attempt by Congress to reform the tax code, the "Tax Cuts and Jobs act of 2017," is about to be passed by Congress this week and will be signed by the president shortly thereafter. It is a very mixed bag of changes that eliminates or modifies a host of tax deductions and credits, lowers tax rates, increases the estate exemption and actually adds a lot of complexity to the already complicated the Internal Revenue Code.
The most compelling provision of the Act is a reduction of the top Corporate tax rate from 35% to 21%. Earlier versions of the Act prior to the conference committee contained a large reduction in tax rates for pass-through entities, such as partnerships, LLC's and S corporations. The final language of the conference report has reduced this relief greatly (potentially 20% of the income is excludable), so that in many cases, taxation of C corporations may be lower than taxation of pass-through entities. This is going to be the key decision that most small businesses will have to make in response to the Act. However, since a C Corp. is still a double tax entity, S corp. taxation may still be the same or less. It all depends on the size of the dividend being taken by the shareholders. Let's look at the following example: The ABC Corp. has $2,000,000 in taxable income before bonuses/dividends to the shareholders.
Here's how this might look under 2017 law and proposed 2018 law:
This analysis assumes that ABC will distribute the net income and therein lies the issue. In an S corp. (or other pass-through) the owners pay tax on the entity’s net income and all of it is distributable tax free when cash flow permits. In real life, these distributions may come in a future year, or may never come and will be used as basis when and if the shareholder sells his interest. In a C corp., the dividend is still taxable whenever the shareholder takes it, and the undistributed amounts do not constitute basis for the shareholder. If the shareholders don't take the dividends, then the current tax that is being paid may be lower ($592,000 v. $420,000); but if you assume that they will eventually take the dividends and or eventually sell their interest, then the single-tax S corp. is still the lower tax entity ($592,000 v. $736,000).
KEY PLANNING POINT - An Selection can be revoked at any time, but to have the revocation be effective at the beginning of the tax year, it must be done within 2 months and 15 days of the beginning of the current tax year (March 15, 2018, for the calendar year entities). In order to elect s status again, the entity must wait 5 tax years. A partnership or LLC can be converted to a C corp. at any time and a selection can be made at any time, but must be made within the first 2 months and 15 days of a tax year for it to be effective for that year. Anyone who is considering a sale in the next few years would probably be ill-advised to revoke an S election or incorporate a partnership. However, a corporation that is in growth mode and will not be in a position to declare dividends for the foreseeable future may benefit from the 21% tax rate, which will allow it to build up equity more cheaply. Please consult with your advisors so that you can make the right decision for you and your business before March 15.
Let's take a look at the rest of the key provisions of the Act and determine whether or not there is any action to be taken:
• To further muddy the waters on C Corp v. S Corp., the Act contains a provision that says that if an S corp. converts to a C corp. within 2 years of the enactment date, that 50% of the distributions that it makes for the next 6 years will deemed to be made from C corp. retained earnings and not S corp. retained earnings, which will make them taxable subject to the 20% maximum rate. They are clearly trying to discourages S corp. revocations.
• Pass through income will be reduced by 20%, subject a limitation based on either 50% of the entities w-2 salary expense or 25% of the entities salary expense increased by 2.5% of the original cost of tangible real property. Companies that operate through multiple entities, some of whom do not have significant payroll may want to revisit their corporate structures ASAP, to make sure that all pass-through income gets the full 20%. This does not apply to most service entities (doctors, lawyers, accountants, etc.)
• 100% cost recovery for property placed in service after 9/27/17 and before 1/1/24 - The threshold is 50% for assets placed in service from 1/1/17 to 9/27/17. For most machinery and equipment under the IRC, placed in service means " when it is first placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, in the production of income, ... The following three elements must be proved: readiness, availability and capability to perform intended function. This may be a year where equipment installed in the summer may not have fully met these three elements prior to 9/27/17....... It is also important to note, that this provision covers new and used equipment.
• State and local taxes will be limited to $10,000 after 2017, therefore you should prepay whatever you think you will owe for the 2017 year, unless you are sure that you will be subject to the Alternative Minimum Tax, which does not allow any deduction of state and local taxes. The Act contains a provision that says that you cannot prepay taxes for a future year and get a tax deduction.
• New car depreciation - Cars placed in service after 12/31/17 will be allowed $10,000 of depreciation in year 1, $16,000 in year 2, $9,600 in year 3 and $5,760 per year thereafter. If you are on the bubble about buying a new car, you may want to wait until 2018.
• Computers and peripherals are no longer considered listed property after 2017, so you may want to buy that new computer or printer in 2018.
• Recovery periods for real property are down for 40 years to 30 years and the rules have been liberalized with respect to qualified leasehold improvements, qualifies restaurant and qualified retail property for assets placed in service after 12/31/17. So if you can push a closing on a piece of property or take the position that an improvement is placed in service next year, you may reap some benefits.
• Like-kind exchange treatment repealed for non real-estate transactions. Open trades, where the taxpayer has disposed of the relinquished property or acquired the replacement property before 12/31/17 are grandfathered in. If you are in the middle of a transaction where you are trading in an older piece of equipment get the paperwork done asap, so you can say that the transaction is grandfathered in. If you wait, the credit that you receive for the trade will be taxable.
• Business entertainment is non-deductible after 12/31/17, although business meals still are (subject to the 50% disallowance). My advice to you is to do a lot of entertaining in the next 2 weeks!
• No deduction is available for amounts paid to settle sexual harassment claims subject to a non-disclosure agreement, so make sure you settle harassment cases before year end!
• Code section 263A which requires non-factory overhead costs to be capitalized into inventory is repealed for any converter or reseller with less than 25 million dollars in gross receipts. Finally, some relief for small business. I would suggest a conservative calculation for 2017, since it will be reversed in the following year.
• Technical termination of partnerships, where more than 50% of the equity changes hands in a 12-month period, is repealed. This should help many family owned smaller partnerships facilitate business succession planning, without having to worry about the tax effects of a technical termination.
• The corporate Alternative Minimum Tax (AMT) is repealed and the exemption amount for the individual AMT is increased to $109,400 (Married Joint) (currently 60% of households with income between $200,000 and $500,000 pay AMT). Medical expense threshold for 2018 is reduced to 7.5% of income and medical expenses are not deductible for AMT. Another planning point may be to defer paying medical expenses until 2018, where they have a greater chance of being deductible and not causing AMT.
• New mortgages are limited to $750,000, so if you are close to buying that big new home, try to close before 12/31/17.
• Miscellaneous itemized deductions are suspended, so you may want to pay your lawyers, brokers, CPA's, etc. before the end of the year.
The following is a list of changes in the Act, which are for information purposes as I do not believe there is any current action to be taken with respect to them:
• A comparison of tax rates Married Joint.
• Section 179 deduction increased to $1,000,000 and the phase-out threshold is increased to $2,500,000.
• Disallowance for interest expense in excess of 30% of taxable income (ebitda) - Not applicable to businesses with less than $25,000,000 in gross income and certain real estate entities can elect out by changing their depreciation methods.
• Net operating losses can no longer be carried back and are limited to 80% of taxable income going forward.
• Domestic activities production deduction is repealed - this was a nice break for domestic manufacturers.
• Standard deduction increased to $24,000 for married Joint filers and $12,000 for single filers.
• Personal exemptions are suspended (they phased out for high income taxpayers anyway.)
• The "Kidde Tax" has been modified to tax unearned income of children based upon the estate and trust rates, rather than the rates paid by their parents - this may save money for some and will speed up processing tax returns, since the children will not have to wait for their parents returns to be finalized.
• Disallowance of business losses in excess of $500,000 (for married taxpayers - $250,000 for individual taxpayers). This means that if you invest in an activity that you actively participate in and it shows a loss of greater than these limits (after netting it with all of your other active trades and businesses), then the excess is carried over to a future tax year.
• The deduction for casualty and theft losses is suspended.
• Child credit is increased to $2,000 per child, with $1,400 refundable even if there is no tax. This phases out at $400,000 of income for married taxpayers.
• Charitable deduction for college athletic seating licenses where the donor receives the right to purchase tickets is revoked.
• Alimony deduction (and income to the spouse) is suspended.
• Moving expense deduction and exclusion is suspended.
• The "Obamacare" individual mandate is repealed.
• Expanded use of Section 529 plans for elementary and secondary private schools, including religious schools.
• New deferral available for certain grants of stock options.
• Estate tax Exemption is doubled (approximately 22.4 million for a married couple.)
For more information about the Tax Cuts and Jobs Act of 2017, contact your accountant or Mitch Klingher, CPA, Klingher Nadler LLP, at firstname.lastname@example.org, or 201-731-3025.
Special Note: Mitch Klingher will conduct a live webinar for the industry on the new tax law on Wednesday, December 27, at 2:00 p.m. Eastern (1:00 p.m. Central; 12 Noon Mountain; and 11:00 a.m. Pacific). To register for this webinar, click the following link: REGISTER FOR THE SPECIAL BULLETIN BROADCAST.