Navigating Tax Reform: How You and Your Business Are Affected
NAVIGATING TAX REFORM:
HOW YOU AND YOUR BUSINESS ARE AFFECTED
Thanks to the massive new tax legislation, big changes went into effect in 2018. Where you live, how you derive your income and the level of income and deductions are key on how these changes determine your effective tax rate.
Most Significant Business Tax Changes:
Corporations and their shareholders. The drop in the corporate tax rate from 35 percent to 21 percent is significant and perhaps makes corporations the biggest winners. This lower rate allows domestic corporations to be more competitive internationally, less influenced by tax incentives, and is designed to free up capital for hiring and distribution to shareholders. In addition, the corporate alternative minimum tax has been repealed.
Owners of pass-through businesses. Under the new Act, owners of pass-through businesses, such as partnerships, S corporations, limited liability companies, and sole proprietorships, would be entitled to a deduction of up to 20% of qualified business income from most activities. Certain service professionals, such as doctors, lawyers, accountants, engineers, consultants, financial service advisors and performing artists, would not receive a benefit of the deduction unless their taxable income is below $315,000 if married filing jointly and $157,500 for all other taxpayers. These provisions are, however, some of the most complex in the new law. There are lots of limits and restrictions to help deter gaming of the tax system.
Small businesses. Increased Section 179 limits will allow businesses to expense up to $1 million in assets, with a phase-out of $2.5 million, up from $500,000.
The 9% domestic production deduction is eliminated in the new law.
Net operating losses can offset only 80% of taxable income, and NOL carrybacks are generally prohibited.
Tax-deferred like-kind exchanges are limited to real property not held primarily for sale but rather held for investment purposes.
Business entertainment deduction. The new Act eliminates the deduction for entertainment expenses, which is used for many business development activities and employee morale building, such as golf outings, tickets to sporting events, company retreats and holiday parties. Additionally, the deduction for transportation fringe benefits is eliminated.
Business interest deduction. The deduction that firms claim for interest on business debt is limited. Net interest write off will be capped at 30% of adjusted taxable income, with disallowed interest carried forward, Firms with $25 million or less in gross receipts and real estate companies will be exempt.
Business losses. The deduction for business losses in individual returns is capped. The amount of trade or business losses that exceed a $500,000 threshold for couples and $250,000 for other filers is nondeductible, but any excess can be carried forward.
Most Significant Individual Tax Changes:
High-income taxpayers. While almost all taxpayers get a reduction in their marginal rate, those most excited about the changes will be those earning more than $500,000 if single or $600,000 if married filing jointly. In 2017, these taxpayers are paying 39.6 percent on their income over $444,550 and $470,700, respectively, but these taxpayers will have a maximum rate of 37 percent in 2018.
Certain Retirees. Under the new Act, the “floor” for the medical expense deduction is reduced for 2017 and 2018. This lower floor means that more retirees will be able to claim a larger proportion of their medical expenses than in prior years. In earlier versions of the law, this deduction was being considered for repeal, which could have adversely impacted many retirees who are entering or residing in nursing homes, where a large part of their substantial entrance and monthly fees consist of deductible medical expenses.
Itemized deductions. By doubling the standard deduction to $24,000 for couples, $12,000 for singles and $18,000 for household heads, the new Act creates a larger “zero percent” bracket, effectively removing many from the tax rolls. Given these much higher amounts, it’s a sure bet that far fewer people will itemize.
Good news for upper-income individuals as well as the phaseout of itemized deductions is scrapped under the new law.
State and local tax deduction will allow taxpayers to deduct property taxes and either income or sales taxes, with a combined limit of only $10,000. This change will primarily affect high earners living in high-tax states like New York, New Jersey and California.
Mortgage interest deduction will have a cap of $750,000, down from $1 million under the current law. Interest on home equity line of credit will be no longer deductible under the new law.
Miscellaneous deductions subject to 2% of adjusted gross income are eliminated under the new law. These deductions included unreimbursed employee expenses, tax preparation fees, advisory fees and safe deposit box fee.
Alimony deduction for post-2018 divorce decrees is eliminated. Recipients will not be taxed on alimony they receive.
Child Tax Credit. The increase in the refundable portion of the child tax credit was a victory for those taxpayers with income so low, they do not generate a tax liability. Under the new Act, the child tax credit is doubled to $2,000 for each dependent under age 17 with up to $1,400 of the child tax credit will now be refundable to taxpayers who do not owe taxes. The income phaseout thresholds are much higher with over $400,000 for couples and $200,000 for all other filers.
There is a new $500 credit for each dependent who is not a qualifying child, including, for example, an elderly parent you take care of or a disabled adult child.
Accountants, lawyers, doctors, and other providers of professional services. Owners, partners, or shareholders of personal service businesses (including doctors, lawyers, and accountants) are not eligible for the full pass-through deduction of 20 percent unless their taxable income is less than $157,500 if single or $315,000 if married. The low-income exception phases out over the span of $50,000 of income for singles or $100,000 if married. This means that any lawyer, doctor, or accountant earning more than $415,000 if married or $207,500 if single, loses out on the 20 percent deduction entirely.
For more information on how CPA Solutions can help you and your business navigate the latest tax return, give us a call at 407-650-9088.