Over the past eight months, we’ve digested the many tax law changes brought by the Tax Cuts and Jobs Act. From a significantly lower corporate tax rate to more generous capital expensing provisions, the act brings a host of planning opportunities. Here are five must-have discussions you should have with your business clients to get them thinking about these valuable tax-saving strategies.
No. 1: Rethink entity choice
The TCJA makes major changes to the choice of entity decision. Because C corporations are now taxed at a flat rate of 21 percent (as opposed to a top rate of 35 percent under prior law), many business owners wonder whether they should structure or restructure their business operations as a C corporation. Unfortunately, the answer isn’t simple.
Perhaps the most important factor to consider is double taxation, meaning that corporate income is taxed once at the entity level and again when it’s distributed to shareholders as dividends. This can be avoided if the corporation retains all profits to finance growth. However, this opens the door to the accumulated earnings tax (or personal holding company tax) if profits accumulate beyond the reasonable needs of the business.
Although C corporations are now more attractive thanks to the lower rate, it may make more sense to continue operating as a pass-through entity. This is particularly true if the taxpayer can claim the full 20 percent deduction for qualified business income, and they plan to exit the business in a relatively short period of time. Generally, it’s risky to hold significant assets that are likely to go up in value (like real estate) in a C corporation. If the assets are sold for substantial gains, it may be impossible to get the profits out of the corporation without double taxation.
No. 2: Acquire assets
Thanks to the TCJA, this is a great time to acquire business assets. A business may be able to take advantage of very generous Section 179 deduction rules. Under these rules, businesses can elect to write off the entire cost of qualifying property, rather than recovering it through depreciation. The maximum amount that can be expensed this year is $1 million (up from $510,000 for 2017). This amount is reduced (but not below zero) by the amount by which the cost of qualifying property exceeds $2.5 million (up from $2.03 million for 2017). But there’s more good news. The Section 179 deduction is now available for certain tangible personal property used predominantly to furnish lodgings and certain improvements to nonresidential real property (roofs, HVAC, fire protection systems, alarm systems, and security systems).
Above and beyond the Section 179 deduction, a business also can claim first-year bonus depreciation. The TCJA establishes a 100 percent first-year deduction for qualified property acquired and placed in service after Sept. 27, 2017, and before Jan. 1, 2023 (or Jan. 1, 2024, for certain property with longer production periods). Unlike under prior law, this provision applies to new and used property. The bonus percentage will phase down for years 2023 through 2026.
This handful of provisions from the Tax Cuts and Jobs Act are worth immediate attention.
No. 3: Adopt a more favorable accounting method
The cash method of accounting, which allows you to recognize sales when cash is received, is attractive to many small businesses due to its simplicity. For tax years beginning after 2017, the ability to use the cash method is greatly expanded. Any entity (other than a tax shelter) with three-year average annual gross receipts of $25 million or less can use the cash method regardless of whether the purchase, production, or sale of merchandise is an income-producing factor.
No. 4: Watch out for new business interest expense limit
Regardless of its form, every business will be subject to a net interest expense disallowance. Starting in 2018, net interest expense in excess of 30 percent of a business’ adjusted taxable income will be disallowed. However, a business won’t be subject to this rule if its average annual gross receipts for the prior three years are $25 million or less. Also, real property trades or businesses can choose to have the rule not apply if they elect the Alternative Depreciation System (ADS) for real property used in their trade or business. Since ADS is a slower way to depreciate property, real property trades or businesses will need to look at the trade-off between currently deducting their business interest expense and deferring depreciation expense.
No. 5: Consider qualified equity grants
The TCJA provides a new tax election for equity-based compensation from private employers. Specifically, the election covers stock received in connection with the exercise of an option or in settlement of a restricted stock unit, or RSU. From a tax perspective, many employees struggle with these forms of compensation because they don’t have the ability to liquidate their shares to pay their tax bill. This new election provides some relief.
Starting with options exercised or RSUs settled after 2017, qualified employees of eligible private companies may elect to defer income from those instruments for up to five years. To take advantage of this election, various requirements must be met. This includes having a written plan under which at least 80 percent of full-time employees are granted stock options or RSUs.
As you can see, this year presents unique planning opportunities thanks to the numerous tax law changes brought by the TCJA. Even with uncertainty about some of the TCJA’s provisions, there are things you can do now to improve your business clients’ situation.
