The Tax Cuts and Jobs Act: What it Means for You, Your Business and Your Estate Plan

By Joe Nagel, Esq., LLM, CPA

The Tax Cuts and Jobs Act (TCJA), passed by Congress and signed into law by President Trump, is the most significant tax legislation enacted in over 30 years. This new tax bill, which went into effect on January 1, 2018, promises to cut taxes for individuals and businesses, stimulate the economy and create necessary jobs for America.

Some of the key provisions affecting individuals and businesses include a tax bracket widening for individuals, a tax rate reduction for individuals and for income generated by pass-through entities, and a significant increase in the estate, gift, and generation-skipping transfer (GST) tax exemption.

Tax Bracket Changes:

Individuals will still have seven tax brackets in the new law, but each one is lower and some are wider. Essentially the brackets change as follows:

No Changes to Capital Gains or NIIT Tax Rates:

Long-term capital gains (assets you’ve owned for more than a year and then sold) are typically taxed at up to 20%.  The Net Investment Income Tax (NIIT) adds a 3.8% surtax on investment income for individuals whose modified adjusted gross income exceeds $200,000 and married filing joint exceeding $250,000.

Estate, Gift and Generation-Skipping Transfer Tax Changes:

Under the prior law, a federal estate tax was imposed on estates which exceeded $5.49 million, or nearly $11 million per married couple. Under the new law, the federal estate, gift, and generation-skipping transfer (GST) tax remains in place but the exemption doubles to $22.4 million per married couple.

Pass-Through Entity Changes:

Business structures like S corporations, LLCs, sole proprietorships, and partnerships pass income through to their owner’s individual return without paying taxes at the company level.  Under the new law, income generated by these pass-through entities is taxed at individual rates less a 20% deduction (which effectively brings the rate lower) for qualified business-related income (QBI) and subject to certain wage limits and exceptions. Some high-income professional service businesses won’t qualify for this new 20% deduction unless they earn less than $157,500 for individual taxpayers and $315,000 for married taxpayers filing jointly.  Limitations and Exclusions include:

• limited to 50% of the owner’s “allocable share” of W-2 compensation paid by the entity during the taxable year
• Investment income excluded (interest, dividends, capital gains)
• Earned income excluded (salaries, guaranteed payments).
• Expires after 12/31/2025

S Corporation Changes:

There are Special rules relating to conversion of S corporations to C corporations within the first 2 years of enactment of this new tax law. In addition, the electing small business trust (ESBT), (which is one of the few types of trusts permitted to be an S corporation shareholder) may now benefit non-resident income beneficiaries. Previously, no non-residents were permitted as shareholders, trust beneficiaries or otherwise.  ESBTs are permitted to take charitable deductions under personal charitable rules and carryover unused contributions for a period of 5 years.

C Corporations Changes:

Corporate America will benefit the most from the new tax law with a 40% effective rate reduction allowing it to be more competitive globally.  Under the Act, the corporate tax rate is lowered to 21% from 35% and is made permanent meaning it will not expire on 12/31/2025.

For C corporation subsidiaries, the dividends received deduction is reduced as follows:

• >20% ownership, 50% deduction (down from 70%)
• 20%-80% ownership, 65% deduction (down from 80%)
• 100% ownership remains 100% deduction.

Comparing Taxes on Annual Operations of C Corporations and Pass‐Through Entities:

(Note: Assumes generic 5% state income tax. Note also, this may overstate S Corp and partnership tax because it includes NII tax of 3.8%.)

Revised Depreciation Rules:

After 9/27/2017, the bonus depreciation (generally for property with useful life less than 20 years) increased to 100% of depreciable basis of the asset acquired.  For 2018, the property no longer needs to be newly manufactured, it can be newly placed in service by the taxpayer (may have previously been placed in use by unrelated taxpayer).

Section 179 Changes:

Under the new law, Section 179 direct expensing of capital assets for small businesses rises from $500,000 to $1 million. In addition, the threshold for phase-out of deduction increases from $2.07 million to $2.5 million, SUV limitation remains $25,000 and expansion for certain real property (qualifying roofs, heating ventilation, air conditioning, fire alarm suppression alarm systems, and beds, furniture, refrigerators, ranges and other appliances) may now qualify as 179 property.

Rental property will likely not qualify for bonus depreciation, but may qualify for 179 subject to income limitations. Applicable recovery period for real property – ADS life of residential real estate reduced to 30 years (non-residential real estate remains 40 years)

Accounting Method Changes:

Under the prior law, C corporations with gross receipts in excess of $5 million were required to use accrual methods of accounting, as were partnerships with 5% or more of a c corporation partner.

Effective 12/31/2017, the limit for C corporations using the cash method is raised to gross receipts of $25 million. Rules for all others remain the same (no gross income testing for cash method for personal service corporations, S corporations or partnerships without C corporation partners).  In addition, any producer or re-seller meeting $25 million gross receipts test is relieved of maintaining a formal COGS schedule, but still must track inventory and take deduction in the year of the sale.

Any producer or re-seller that meets $25 million gross receipts test is exempt from the requirement to allocate overhead to inventory as required by 263A. The new law expands availability of completed contract method from taxpayers with gross receipts below $10 million to taxpayers with gross receipts below $25 million (for contracts expected to be completed within 2 years).

Restrictions on Interest Deductions:

Effective after 12/31/2017, the tax law limits the amount of deductible interest pursuant to IRC Section 163(j) to the aggregate of:

• The business interest income for that year + 30% of the taxpayer’s adjusted taxable income for the year + the taxpayer’s floor plan financing interest for that year. Any amounts not currently deductible are carried forward indefinitely

But this does not apply to taxpayers who meet the $25 million gross receipts test. This test is met if the average annual gross receipts for a 3 year period ending the prior tax year do not exceed $25 million.

Note:  The limitation on interest deduction repeals and replaces the earnings stripping rules (paying interest from a US entity to a foreign entity that did not include the interest in US sourced income).

International Corporate Taxation:

Prior law taxed US taxpayers on worldwide income and provided a foreign tax credit for taxes paid overseas. This new law adopts a “territorial income tax system, which only taxes companies on US earnings. Foreign earnings are excluded from the US tax base. All cash repatriated into the US is generally nontaxable when transferred, but no foreign tax credit will be allowed for taxes paid overseas. Complex rules are provided to ensure that corporations do not have excess nontaxable returns on earnings from low tax jurisdictions. Cash is no longer taxed on repatriation, but currently overseas earnings that are not taxed (since 1986) are subject to immediate tax. Liquid assets will be taxed at 15.5% and non-liquid assets taxed at 8% (but exclude previously taxed Subpart F income and other previously taxed income).

Affected taxpayers (controlled foreign corporations, CFCs and those owning more than 10% of a foreign corporation) will be required to pay the liability over an 8 year period – 8% of the liability payable in years 1-5, 15% in year 6, 20% in year 7, and 25% in year 8.   Corporations may use deemed paid foreign tax credits, but individuals must make election to do so under IRC 962 (see professional to evaluate).

C corporations get 100% dividends received deduction on actual repatriation of foreign income in the future and any foreign withholding will become a tax expense. C corporations must determine how all international provisions impact the use of existing excess foreign tax credits (can go back 10 years and change to expense,) Net Operating Loss and other recorded deferred tax assets and deferred tax liabilities.

Net Operating Loss (NOL) Changes:

Effective for years beginning after 12/31/2017, the 2 year carry back provision for NOLs is repealed (except for certain farming losses and casualty insurance companies). NOLs may be carried forward.

Education Credits Still Available; 529 Accounts:

No changes were made to the American Opportunity Credit (AOC) or the Lifetime Learning Credit (LLC).

Eligible students may qualify for the AOC, which provides a credit of up to $2,500 per year (40% of which is refundable) for qualified tuition and related expenses for each of the first four years of college (or certain other degree programs).  Eligible taxpayers may qualify for the LLC, which provides a credit of up to $2,000 per return, not per student. 529 Accounts were expanded to allow distributions up to $10k/year for primary and secondary education.

Standard Deduction Versus Itemized Deductions:

As a result of the increase in the standard deduction, many taxpayers who previously itemized will most likely claim the standard deduction going forward.

The standard deduction (remember, no itemization required) increases to:

• $12,000 for individuals,
• $18,000 for head of household, and
• $24,000 for married couples filing jointly.

Add $1,300 for individuals over age 65, blind, or disabled ($1,600 for unmarried taxpayers).  Personal exemptions will disappear starting January 1, 2018 through December 31, 2025. In 2017, this was $4,050 per person on the tax return, but was subject to phase-out for high income taxpayers.

Eliminated Deductions:

Limited Deductions:

Modified Deductions:

Standard Deduction and Personal Exemption Example – Married Couple, No Children:

The total deduction is bigger under the new law for a married couple with no children but is smaller for a married couple with 2 children, however given the rate changes and child tax credit, this couple may still be better off.

As with itemized deductions, many “above-the-line” adjustments have also been eliminated or limited.

“Above-the-line” Adjustments repealed:

“Above-the-line “Adjustments Retained:

Child Tax Credit Changes:

Under the old law the Child Tax Credit was $1,000 and was refundable.  Under the new law, the child tax credit doubles to $2,000 per child and will be refundable up to $1,400, subject to phase outs for higher income taxpayers. This law also includes a new, temporary $500 nonrefundable credit for other qualifying dependents (for example, older adults) that would not qualify for the child tax credit.

Health Care Mandate Repealed:

The Affordable Care Act (also known as ACA or Obamacare) individual mandate is repealed.

Starting January 1, 2019, there will be no tax penalty for failure to have health insurance coverage. However, this tax law does not appear to alter Medicaid expansion, pre-existing condition coverage, enrollment period requirements, or other aspects of the ACA.

Alternative Minimum Tax (AMT) Changes:

Under the new law, the AMT is permanently repealed for c corporations and for individuals the exemptions increased to $70,300 for individuals and $109,400 for married taxpayers filing jointly, which means it will apply to fewer taxpayers.

Modifications to Fringe Benefits through 2026:

• Repeal of business entertainment expenses. Under prior law 50% of expenses related to entertaining clients for trade or business were deductible.
• Repeal of qualified transportation fringe benefits including subsidized transit passes, van pool transportation, subsidized parking at employer’s premises, bicycle reimbursement.
• Reimbursed moving expenses not deductible going forward, except for member of armed forces.
• Employee achievement award exclusion repealed.
• $1 million limit on executive compensation for public companies under IRC 162(m) changed to remove exclusion for performance based compensation and extended to CFOs.

In summary, the Tax Cuts and Jobs Act appears to be good for America, the economy and the stock market putting money back into taxpayers’ pockets and putting tax savings back into the economy. If you have any questions regarding this new tax law and how it affects your business or your estate, please contact us at 404-255-7400 or www.hoffmanestatelaw.com.