There have been many articles written about The Tax Cuts and Jobs Act since it was signed into law on Dec. 22, 2017. There are many provisions within the law that will change the way both individuals and business owners will plan for future tax filings and run their businesses. In this article, I review some of the provisions as they relate to business owners and certain niches in the commercial electrical contracting industry and provide some guidance on changes that may be appropriate for the exiting business owner.
First and foremost, it will be less expensive to operate your business in 2018 than it was in 2017. Aside from the various provisions one key element is that tax rates have dropped. Other key elements are as follows:
- "C" corporations will enjoy the greatest benefit as rates dropped from 35 percent to 21 percent.
- Individual rates will still have seven brackets, but each bracket has been reduced by 2 to 4 percentage points.
- The income brackets have been slightly increased, so it will take more taxable income for an individual to move into the next bracket.
- Pass-through entities (sole proprietors, partnerships, "S" corporations and trusts and estates) will still be taxed at the individual income tax rates; however, there are provisions that can effectively eliminate 20 percent of the income from being taxed.
A key provision that will influence the marketing side of businesses in general is the elimination of the meals and entertainment deduction. The previous law allowed for a 50-percent deduction for any meals and entertainment expenses incurred in the normal course of a business’ sales cycle. This deduction has been removed. Meals paid for the benefit of employees that are necessary for them to work beyond normal hours continue to be 100-percent deductible.
A provision that provides a benefit to a business owner’s tax situation is the increase of the Section 179 deduction. This deduction allows a business owner to fully expense the cost of a capital asset in the year it was placed in service. The previous deduction limited expensing to $500,000. The new is $1,000,000, and the phase-out was increased from $2,000,000 to $2,500,000.
The definition of “eligible property” was also expanded. Here’s where the new provision can really help commercial roofing companies increase revenue. The provision expands the definition of qualified real property eligible for Section 179 expensing to include improvements to non-residential real property placed in service after the date such property was first placed in service. This expanded definition includes roofs, heating, ventilation, air conditioning property, fire protection and alarm systems, and security systems.
This means commercial electrical contractors installing fire protection and alarm systems can now fully expense the cost up to $1,000,000, provided they do not acquire other tangible personal property that exceeds the $2,500,000 cap. The intention is to encourage owners to invest in updated technologies and provide additional opportunities and revenues in this niche.
Previous law required the cost of construction for a fire protection and alarm system to be capitalized and depreciated over 39 years. In addition to the Section 179 deduction, the bonus depreciation rules were also expanded. This is one of the few changes that affect 2017 tax computations. The provisions allow for property acquired after Sept. 27, 2017 and placed in service prior to Dec. 31, 2022 to expense 100 percent of the cost.
Where this provision previously allowed for expensing of new equipment only, the new law expands the definition to include used equipment.
Another key provision in the Tax Cuts and Jobs Act affects pass-through entities, which were granted a further reduction to compete with the "C" corporation tax break.
There is a specific provision in the Act called the Section 199A deduction. This part of the law provides for a 20-percent deduction for owners of pass-through entities. The general 20-percent deduction is applicable for single taxpayers with taxable income under $157,500, and joint filers with taxable income under $315,000 will generally get the full 20-percent deduction. However, as income levels increase above these limits, the formula deduction looks at W-2 wages paid to employees and at the depreciable property held by the pass-through entity.
For these high-income taxpayers, in some cases, the deduction is limited to 50 percent of the W-2 wages paid by the entity or 25 percent of the wages paid by the entity plus 2.5 percent of qualified property’s original cost. For the property to qualify, it cannot be greater than 10 years old or past its last full year of depreciation. Income levels between the upper and lower limits get a phase-in of the W-2 and property requirements.
People who conduct business in the personal service industry will lose the deduction altogether once their income exceeds the upper limits. There is an exception to this rule, however. Engineers and architects do not fall under the exclusion and would follow the ordinary business definition for application of the 199A deduction.
This begs the question, "why not convert the pass-through entity to a "C" corporation?" On the surface, one would think this is a wise decision. However, it is important to note that anytime income is taken out of a "C" corporation, there is generally a second layer of tax. For an “exiting owner,” however, there could be some good opportunities to utilize a "C" corporation as an exiting tool and eliminate capital gains on the transaction while benefiting from a lower annual income tax rate.
There are some other key provisions that business owners should be aware of under the new Act. They are as follows:
- The lifetime gift and estate tax exclusion has been doubled and now is $11,200,000 per individual. Therefore, married couples with estates below $22,400,000 will be free of federal estate and gift taxes.
- The annual gift tax exclusion has been increased to $15,000 per donor per gift.
- Personal exemptions have been eliminated and are now covered under the increased $24,000 standard deduction.
- Miscellaneous itemized deductions have been eliminated. Investment fees are no longer deductible.
- Medical expenses are now deductible in excess of 7.5 percent of adjusted gross income.
- Alimony payments for agreements entered into after Dec. 31, 2018 are no longer deductible by the payer or includible as income by the recipient.
- Interest home equity lines of credit are no longer deductible.
- Mortgage interest on loans in excess of $750,000 are no longer deductible.
- Net operating losses generated from business, trust and estates that exceed current year income in excess of $250,000 for singles and $500,000 for joint filers cannot be fully deducted in the current year. It must be carried forward and subject to 90 percent of the subsequent year’s income.
- The alternative minimum tax (AMT) has been repealed for “C" corporations. The individual AMT still exists; however, the exemption amount has been increased substantially.
- When itemizing deductions, the tax deduction is capped at $10,000 annually. There is no cap on tax deductions for businesses.
- 1031 Gain deferral has been changed to eliminate personal property and now only applies to real estate transactions.
Once you've completed a thorough analysis of how these tax law changes will affect your business, there may be a need to make changes in your financial and legal strategies such as operating agreements, income allocation, wage and income distributions and estate tax documents.
Furthermore, it is important to understand that, similar to previous tax bills that were enacted into law, there are sunset provisions to consider. With the exception of the "C" corporation tax rates, many of the provisions of this law will sunset, or expire, on Dec. 31, 2025.