When it comes to business tax rates, the general philosophy of the bill demonstrates the GOP predilection to reward their supporters. As was true for the personal tax situation, PL 115-97 benefits businesses that thrive in “Red States” (agriculture, manufacturing) and penalizes those that prevail throughout the “Blue States” (finance and media).
As it stands now, corporations- just like individual tax payers- pay different marginal tax rates. Here’s where they’re for 2017.
|Net Income||Marginal Tax Rate|
|< $ 50,000||15%|
|$ 50,001 to $ 75,000||25%|
|$75,001 to $10,000,000||34%|
Moreover, when a company has more than $ 10 million in profits, there is no 25% nor 34% marginal rate. In other words, it is obligated to pay 15% on the first $ 50K and then 35% on the rest. IF the profits exceed $ 15 million, the 34% rate gets phased out until $ 18.33 million, when the only tax rates to pay are the first 15% bracket, with 35% on the rest of business income.
First, a bit of good news obtains for personal service corporations. These are firms that provide health services, legal representation, engineering, architecture, accounting, actuary services, performing arts, or consulting. These corporations had always been taxed at a straight 35%. (Hmm. Now you know why over the years, these firms now form LLC and NOT corporations!) But, the House planned to hit these firms up for a higher tax rate of 25% (5% higher than their proposed rates for normal corporations). Except now, there is no specification of a special rate for personal service corporations. They pay the same marginal tax rates as every other firm. (Not quite the rules for those personal service entities that are pass-through, as we will see below.)
While the AMT remains in force for individuals, the concept has been eradicated when it comes to business income. Moreover, those firms that paid AMT may be able to use those funds to refund the taxes that will be due for taxes due between 2018 and 2021 (inclusive) up to 50% of the AMT (100% for tax years 2021 and 2022).
Then, there’s pass-through entities. As discussed in a previous post, 20% of the distributions from pass-through entities (LLC, partnerships, S corporations, Schedule C [self-employed) businesses, trusts, and estates) will be not taxed. Only 80% of that income will be subject to individual (or married) tax rates. There are phase-outs, depending upon one’s marital status and income, as well as how much wages the firm provided its employees. (There’s more on this- and also the loss carry-forward penalty of this provision in Part 2 of this series).
(This pass-through benefit covers 10 million or 40% of the total number of pass-throughs. And, pass-throughs garner some 56% of all business income. You should also know that the top 1% income-earners receive 70% of all partnership income in the US. But, the pass-through benefits will be attenuated because of the wage cap limiting this tax provision.)
Active owners (remember- they don’t get the benefit of that reduced tax rate for pass-throughs) who are in the professional services (lawyers, doctors, accountants, etc.) will probably be paying a 37% tax rate from now on. Other active owners (such as retailers or manufacturers) will be treated as CEO and investors. As such, 80% of the pass-through income will be taxed at the individual’s tax rate.
(By the way, you can bet this will change the way the IRS decides what is reasonable compensation for such firms. It will become standard for reasonable compensation to be at least 30% of the potential pass-through revenue, if not at an even higher level.)
Capital and Depreciation
Current law lets businesses “write off” their expenses for qualified property faster than normally. The “qualified property” are those items subject to MACRS (modified accelerated cost recovery system) with a recovery period of 20 years or less. The additional write off is 50% in 2017, 40% in 2018, and 30% in 2019.
The new rules will cover all “qualified property” placed in service between 27 September 2017 and 1 January 2023- and will allow the firm to literally write off the costs. 100% of the cost will be able to be expensed immediately. (You did notice this expires after 5 years, right?)
Qualified property now includes real estate (non-residential) needs such as roofing, HVAC (Heating, ventilation, and air conditioning) equipment, fire protection and alarms, as well as security property.
This is separate and apart from Section 179, the special depreciation rules that have been in force for almost 6 decades now. Any property that costs $ 1KK or less can be “expensed” in the calendar year of purchase. Up to $ 2.5 million can be handled this way- and the only limitation is the amount of profits the firm has. (You can’t create “negative” income via a Section 179 deduction. On top of this, there is a $ 25K sport utility vehicle limitation. But, all three numbers (the $ 1 KK, the $ 2.5KK, and the $ 25K limits) will be subject to inflation after 2018.
More important for many of the smaller businesses is the limits of car depreciation are greatly increased. The limits have been raised to $ 10K for the first year of car ownership (about 3X as high as before), $ 16K for year 2, and $ 9600 for year three. Subsequent year’s depreciation is set at $ 5760. (We’ve had many clients need 6 years to depreciate a moderate priced vehicle [$ 35K]. Now, this will only take 3 years!)
Right now, some small businesses are eligible to use “cash accounting”. Cash accounting means the firm recognizes income when it is received and expenses when they are paid. Accrual accounting would mean that income is recognized when a client/customer is billed (regardless of when they pay the tab) and expenses are recognized once the bill is received (even if you have not paid the bill).
Which small businesses are eligible? Partnerships (only those with no corporate partner), sole proprietorships, and S entities. Corporations- whether alone or in a partnership can only use cash accounting if they accrue less than $ 5 million in gross receipts. Farms (corporate entities or in partnership with a corporation) need to abandon cash accounting when their gross receipts exceed $ 1 million.
With one big proviso. If the firm’s business involved inventory, then cash accounting is out once the gross receipts reach $ 1 million. (There are very specialized exceptions which let the cutoff be $ 10 million, but these are pretty arcane.)
Under the new law, Cash Accounting will be allowable for all entities, as long as annual gross revenue does not exceed $ 25 million.
There are also new rules for companies that effect long-term contracts. (Many of our R&D projects involved 3-year terms. That’s the sort of deal we are discussing here.) When these relationships exist, the firm must use the percentage of completion method to account for income and expenses. Unless, for the past three years, gross receipts did not exceed $10 million a year- then percentage of completion can even be used for projects that have a two-year time frame or less. The proposed law will raise that exception to $ 25 million.
The Deductibility of Business Interest
During CY 2017, businesses can deduct the costs for interest for items that have been financed. Under the new law, only that interest that equals 30% or less of the adjusted taxable income (not counting taxes, depreciation, amortization, and the total amount of interest paid) will be deductible. And, if the entity is a partnership, the rule applies to the entire entity (the one that files an income tax return- not to the individual partners, who will receive their pro-rata share listed on the K-1. (The K-1 is akin to a W-2 for employees; the K-1 explains how corporate revenue and expenses are allocated to the shareholders.) Unless- the entity has a gross income of $ 25 million or less- those smaller enterprises can deduct all the interest they pay.
The legislation proposal provides that $ 25 million exception because the House recognizes that smaller businesses are less likely to find investors (who buy stock and, therefore, invest capital in the firm). These smaller entities generally must borrow money for their equipment, since they lack access to the stock market.
Oh, and commercial real estate firms also have special rules that make this interest deduction rule less onerous on their continued operation. (Yes, those firms have been big supporters of the GOP.)