Our Read on issues that impact businesses from The Tax Cuts and Jobs Act
By Martin Medeiros, Esq., CIPP/US
The time to plan is urgent. The sausage-making is over with the new tax law being framed as a “tax reform” by some,
a “tax cut” by some, “good for the economy,” and “bad for the economy,” by others. The arguments in the processing are now irrelevant, but the time to plan is now: various provisions of the law will take effect in just weeks. What is in this rendered product? Below is our current understanding of the new law as it impacts businesses and equity holders, its voluminous provisions, as with any comprehensive legislation, will ensure many actions, interpretations, and unintended consequences. To some extent, the law is still a Rorschach test, so meet with your tax planner. For now, this is our read:
- Entity Type – Pass Through. Pass through entities, such as certain corporations, partnerships, limited liabilities, and others will take note of the changes. We’ve received many requests to form new entitles at the end of this year. Now and 2018 may incent some to file as soon as possible and we expect filings to accelerate now. The new tax bill benefits sole proprietorships, partnerships, and companies who comply with and have timely filed Internal Revenue Service form 2553 to claim tax treatment under subchapter S of the Internal Revenue Code to be recognized as S corporations. These “pass through” entities allow individuals to claim business income on their IRS Form 1040. If you have a primary or secondary business, it may be time to form an entity (for various reasons, but now for tax reasons primarily) as it generally creates a 20 percent reduction in tax rates for business income for the first $315,000 of qualified business income (filing jointly) or $157,500 per year (for single filers) for individuals who are owners of these entities. For higher income individuals, that rate goes up to 29.6 percent.
- Entity Type – C Corporations. Organizations that give liquidity preferences in their equity holders, such as preferred shares, will see a very significant landscape change. Now taxed at a rate of 21 percent, this is a significant drop in the top rate from 35 percent and puts the United States virtually in line with other modern economies.
- Entity Type – International Corporations. Major changes for US multinational corporations. Taxing all profits on US-based corporations, regardless of where they are earned, is ended; profits are taxed on US-based profits only. This aligns the IRC with most industrialized nations and makes some tax evading strategies less attractive. Repatriation of business profits held overseas are subject to a 8% tax on non-cash assets and 15.5 percent tax on cash (or certain similar liquid assets) held overseas. Shifting profits to low tax jurisdictions is prevented, and sets an alternative minimum tax on funds between U.S. corporations and foreign affiliates. The new law limits offsets on intangible assets, such as patents, trademarks, copyrights, and trade secrets.
- Entity Type – Fund Management Companies. The new law preserves some of law, and limits other areas. It leaves in place the “carried interest” loophole for venture capitalists, private equity fund managers, and some hedge fund managers, contrary to prior versions that closed. This allows managers to pay a lower capital gains tax rate on much of their income from investments held more than a year, as they typically are not paid normal salaries but are interested in risky upside gambles. However, a new rule would extend that holding period to three years, putting the benefit out of reach for some fund managers but preserving its availability for many. We predict many three-year exit horizons on investments and venture backed start-ups.
- Alternative Energy. Early versions threatened to eliminate this credit. Biomass, geothermal, solar, and hydropower were preserved in the last version.
- Equipment / Property purchases. Small businesses can deduct a larger portion of their equipment purchases. Talk to your CPA about how a capital lease versus an operating lease may have different treatment. The reason is that owners are also losing interest deductions on loans. Those loans may be used to finance equipment. As I read it, the Internal Revenue Code Section 179 deduction allowing certain equipment purchases to be deducted up front rather than depreciate over a period of years changed to $1 million in purchases, up from the current level of $510,000. For larger equipment, up front deductions rather than depreciation are allowed through 2022 if your annual revenue is less than $25 million. Procurement teams could find themselves very busy in Q1.
- Real Estate. Landlords will be able to continue fully deducting their mortgage interest.
- Alternative Minimum Taxes. The AMT remains for individuals (if over around $70K annual income) but is lower for individual equity holders. The corporate AMT seems to be gone. There is an AMT on international profit handling as above.
- High Taxing States Deductions Capped. If you pay high state and local taxes, you are limited to $10,000 in deductions.
This is our read on the business-related issues and does not speak to issues around individual rates, mortgage deductions, Affordable Care Act, petroleum drilling provisions, or other provisions the bill also addresses. This article should not be relied on and is not intended as legal or tax planning advice, please consult your attorney in your jurisdiction and your Certified Public Accountant to obtain such advice. Feel free to contact us if you have feedback, questions or comments at 503-343-3303 or [email protected].