The Tax Cuts and Jobs Act
passed Congress on December 20, 2017 and was signed into law by the President
on December 22, 2017 (the enactment date) and is generally effective for tax
years beginning after 2017. This is the
seventh in a series of articles reviewing some of the more important
changes. This post deals with the new
rules for selected business deductions, like-kind exchanges, and small business
tax accounting methods.
Business Meals and Entertainment
No deduction is permitted
after 2017 for business entertainment, amusement or recreation activities,
facilities, or related membership dues. There
appears to be a difference of opinion about whether meals for client meetings
remain 50% deductible. Are meals part of
entertainment? IRS Publication 463
states that meals are a form of entertainment.
Therefore, there is a chance that business meals may not be
deductible! IRS guidance is needed. But it appears that if meals are connected
with entertainment they are not deductible.
For business meals not connected with entertainment, they should remain
50% deductible. Other changes include:
· Meals furnished to employees for the convenience of
the employer are no longer 100% deductible after 2017 but are 50% deductible
through 2025. After 2025 such meals will
no longer be deductible.
· Employee business meals incurred while traveling
remain 50% deductible.
· Meals are 100% deductible if the cost is included in
employee wages, billed to or reimbursed by clients, or incurred for social,
recreational, or similar activities primarily for the benefit of employees
other than the highly compensated (e.g., office holiday parties or summer
office picnics).
Business Interest Expense
For tax years beginning
after 2017, deductible business interest expense is limited to 30% of adjusted
taxable income plus business interest income.
There is no grandfathering of existing debt! The business interest limitation does not
apply to investment interest expense which has its own limitation. Adjustments required to calculate adjusted
taxable income include the following:
· Nonbusiness income and deductions are excluded.
· The net operating loss deduction is excluded.
· The 20% qualified business income deduction is
excluded.
· Depreciation, amortization, and depletion (EBITDA) are
excluded for tax years beginning in 2018 through 2021.
· For tax years beginning after 2021, depreciation,
amortization, and depletion expenses are not added back (EBIT) thus lowering
the 30% deduction threshold.
The IRS issued Notice
2018-28 wherein it states that for, for purposes of the limitation for C
corporations, all interest income is considered business interest income
and all interest expense is considered business interest expense.
The limitation is determined
at the entity filer level and not at the owner level. There are complicated pass-through entity
allocation rules for allocating excess adjusted taxable income or interest
expense. Disallowed interest can be
carried forward indefinitely. Businesses
exempt from the limitation include:
· Floor plan financing businesses (e.g., auto, boat,
farm implement dealers).
· Companies with $25 million or less average annual
gross receipts are exempted.
· Farming businesses and real property development,
construction, rental, operation, brokerage businesses may elect out of the
interest expense limitation. But the
election comes at the cost of having to use longer depreciable periods and
losing the ability to claim bonus depreciation.
Some implications of the
30% interest expense limitation to consider are the following:
· Taxpayers may want to elect to “slow down” tax
depreciation after 2021 to increase the adjusted taxable income limitation.
· If earnings decline, there could be a loss of the
interest deduction.
· While the disallowed interest expense carries over, it
will still be limited to 30% of EBITDA/EBIT in the future, whereas if the
interest expense were part of a net operating loss, it could offset 80% of
taxable income.
· If a taxpayer has multiple entities, some with debt
and some without, the debt may need to be restructured across entities since
the 30% test appears to be applied on a separate business entity basis. IRS guidance is needed.
· Small businesses with a high level of debt that will
cross the $25 million gross receipt threshold will need to plan for a possible
interest expense limitation.
Like-Kind Exchanges
Tax deferred like-kind
exchanges are restricted to real property exchanges after 2017. After 2017, business or investment personal
property exchanges are taxable. A
transition rule permits personal property exchanges to be completed tax-free in
2018 where the taxpayer disposed of the relinquished property (forward
exchange) or acquired the replacement property (reverse exchange) before 2018.
Businesses that trade in
old machinery and equipment for new will be treated as selling their old machinery
and equipment since the exchange is now taxable. But with 100% bonus depreciation (through
2022) and with §179 expensing, there might not be a net tax increase, at least
through 2022.
Small Business Tax Accounting Simplified
For tax years beginning
after 2017, tax accounting methods are simplified for businesses having average
annual gross receipts for the 3-prior tax years of $25 million or less. Simplifications include:
· C corporations may use the cash method of tax
accounting. Previously C corporations
could only use the cash method if average annual receipts were $5 million or
less. Prior law exceptions to the
required use of the accrual method continue to apply for personal service
corporations, partnerships without C corporation partners, and S corporations
regardless of the amount of their gross receipts.
· Businesses with inventory can use the cash method. Previously businesses with inventory could
only use the cash method if average annual gross receipts were $1 million or
less ($10 million or less for certain industries).
· The uniform capitalization of indirect costs to ending
inventory is not required for resellers or producers. Previously resellers were exempt if average
annual receipts were $10 million or less, and there was no small taxpayer
exception for producers.
· Construction contractors may use the completed
contract method instead of the percentage of completion method for construction
contracts entered into after 2017 that are expected to be completed within two
years. Previously the exception to the
percentage of completion method had a $10 million average annual gross receipt
test. However, the percentage of
completion method is still required for alternative minimum tax purposes and so
full simplification for small contractors has not been achieved.