2017 proposed tax Changes for Small businesses

The Tax Cuts and Jobs Act, released on Nov. 2 and scheduled to be marked up by House Ways and Means on Nov. 6, would make major changes to taxation of corporations and other businesses. Below are some of the changes that are being proposed.

Changes to Corporate Tax Rates

Under the Act, the corporate tax rate would generally be a flat 20% rate beginning in 2018, eliminating the current graduated rates of 15% (for taxable income of $0-$50,000), 25% (for taxable income of $50,001-$75,000), 34% (for taxable income of $75,001-$10,000,000), and 35% (for taxable income over $10,000,000). (Act Sec. 3001)

The Act would provide that personal services corporations would be subject to a flat 25% corporate tax rate, rather than the current 35% rate, effective for tax years beginning after 2017. 

100% Cost Recovery Deduction

Under the Act, instead of bonus depreciation for qualified property, taxpayers would be able to fully and immediately expense 100% of the cost of qualified property acquired and placed in service after Sept. 27, 2017 and before Jan. 1, 2023 (with an additional year for certain qualified property with a longer production period). (Act Sec. 3101(a), Act Sec. 3101(b))

Property would be eligible for this immediate expensing if it is the taxpayer’s first use, repealing the current requirement that the original use of the property begin with the taxpayer. (Act Sec. 3101(c)) The Act would provide that qualified property would not include any property used by a regulated public utility company or any property used in a real property trade or business. (Act Sec. 3101(d))

Under the Act, the taxpayer’s election to use the minimum tax credit in lieu of the additional depreciation would be repealed, effective for tax years beginning after 2017. 

Increased Code 179 Expensing

Under the Act, for purposes of Code Sec. 179 small business expensing, the limitation on the amount that could be expensed would be increased to $5 million (from the current $500,000), and the phase-out amount would be increased to $20 million (from the current $2 million), effective for tax years beginning after 2017 through tax years beginning before 2023. Both amounts would be indexed for inflation. The definition of section 179 property would also include qualified energy efficient heating and air-conditioning property permanently, effective for property acquired and placed in service after Nov. 2, 2017. (Act Sec. 3102)

Small Business Accounting Method Reforms

The ACT provides several provisions reforming and simplifying accounting methods for small businesses:

Cash method of accounting. Under current law, a corporation or partnership with a corporate partner may only use the cash method of accounting if its average gross receipts do not exceed $5 million for all prior years (including the prior tax years of any predecessor of the entity). Under the Act, the $5 million threshold for corporations and partnerships with a corporate partner would be increased to $25 million and the requirement that such businesses satisfy the requirement for all prior years would be repealed. (Act Sec. 3202(a))

 An exception allows certain family farm corporations to qualify if its gross receipts do not exceed $25 million. Under the Act, the increased $25 million threshold (above) would be extended to farm corporations and farm partnerships with a corporate partner, as well as family farm corporations (the average gross receipts test would be indexed for inflation). Under current law, farm corporations and farm partnerships with a corporate partner may only use the cash method of accounting if their gross receipts do not exceed $1 million in any year.

Accounting for inventories. Under the Act, businesses with average gross receipts of $25 million or less would be permitted to use the cash method of accounting even if the business has inventories. (Act Sec. 3202(c)) In contrast, under current law, the cash method can be used for certain small businesses with average gross receipts of not more than $1 million (for businesses in certain industries whose annual gross receipts do not exceed $10 million). Under the cash method, the business could account for inventory as non-incidental materials and supplies. Under the Act, a business with inventories that qualifies for and uses the cash method would be able to account for its inventories using its method of accounting reflected on its financial statements or its books and records.

Capitalization and inclusion of certain expenses in inventory costs. Under the Act, businesses with average gross receipts of $25 million or less would be fully exempt from the uniform capitalization (UNICAP) rules. (Act Sec. 3202(b)) The UNICAP rules generally require certain direct and indirect costs associated with real or tangible personal property manufactured by a business to be included in either inventory or capitalized into the basis of such property. The Act’s exemption would apply to real and personal property acquired or manufactured by such business. Greenbox Capital knows how to cater to the financial circumstances typical of small businesses.

Accounting for long-term contracts. Under current law, an exception from the requirement to use the percentage-of-completion method is provided for certain businesses with average annual gross receipts of $10 million or less in the preceding three years. Under the Act, the $10 million average gross receipts exception to the percentage-of-completion method would be increased to $25 million, effective for tax years beginning after 2017. (Act Sec. 3202(d)). Businesses that meet the increased average gross receipts test would be allowed to use the completed-contract method (or any other permissible exempt contract method).

Effective date. The above provisions would be effective for tax years beginning after 2017.

Limits on Deduction of Business Interest.

Under the Act, every business, regardless of its form, would be subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income. The net interest expense disallowance would be determined at the tax filer level. For example, it would be determined at the partnership level rather than the partner level. Adjusted taxable income is a business’s taxable income computed without regard to business interest expense, business interest income, net operating losses (NOLs), and depreciation, amortization, and depletion. (Act Sec. 3301(a)) Any interest amounts so disallowed would be carried forward to the succeeding five tax years and would be an attribute of the business (as opposed to its owners). (Act Sec. 3301(b))

Special rules would apply to allow a pass-through entity’s unused interest limitation for the tax year to be used by the pass-through entity’s owners and to ensure that net income from pass-through entities would not be double counted at the partner level. These provisions would not apply to certain regulated public utilities and real property trades or businesses, which would be ineligible for full expensing under Act Sec. 3101 (see above). (Act Sec. 3301(a))

Under the Act, businesses with average gross receipts of $25 million or less would be exempt from the above interest limitation rules in Act Sec. 3301. (Act Sec. 3203)

Under the Act, the current earning stripping rules under Code Sec. 163(j) would be repealed.

Effective date. The above provisions would be effective for tax years beginning after 2017.

NOL Deduction Limited

Under the Act, taxpayers would be able to deduct a net operating loss (NOL) carryover or carryback only to the extent of 90% of the taxpayer’s taxable income (determined without regard to the NOL deduction). This would conform to the current AMT rule. The Act would also generally repeal all carrybacks but provide a special one-year carryback for small businesses and farms in the case of certain casualty and disaster losses. This provision generally would be effective for losses arising in tax years beginning after 2017.

In the case of any net operating loss, specified liability loss, excess interest loss or eligible loss, carrybacks would be permitted in a tax year beginning in 2017, as long as the NOL is not attributable to the increased expensing that would be allowed under Sec. 3101. In addition, the Act would allow NOLs arising in tax years beginning after 2017 and that are carried forward to be increased by an interest factor to preserve its value. (Act Sec. 3302)

Business-related Exclusions, Deductions, etc.

Like-kind exchanges. Under the Act, the rule allowing the deferral of gain on like-kind exchanges would be modified to allow for like-kind exchanges only with respect to real property. (Act Sec. 3303) Under current law, a special rule provides that no gain or loss is recognized to the extent that property—which includes a wide range of property from real estate to tangible personal property—held for productive use in the taxpayer’s trade or business, or property held for investment purposes, is exchanged for property of a like-kind that also is held for productive use in a trade or business or for investment.

Effective date. The provisions would generally be effective for transfers after 2017. A transition rule would allow like-kind exchanges of personal property to be completed if the taxpayer has either disposed of the relinquished property or acquired the replacement property on or before Dec. 31, 2017.

Contributions to capital. Under the Act, the gross income of a corporation would include contributions to its capital, to the extent the amount of money and fair market value of property contributed to the corporation exceeds the fair market value of any stock that is issued in exchange for such money or property. Similar rules would apply to contributions to the capital of any non-corporate entity, such as a partnership. Under current law, the gross income of a corporation generally does not include contributions to its capital (i.e., transfers of money or property to the corporation by a non-shareholder such as a government entity). (Act Sec. 3304)

Effective date. The provision would be effective for contributions made, and transactions entered into, after the date of enactment.

Entertainment and other expenses. Under the Act, no deduction would be allowed for entertainment, amusement or recreation activities, facilities, or membership dues relating to such activities or other social purposes. In addition, no deduction would be allowed for transportation fringe benefits, benefits in the form of on-premises gyms and other athletic facilities, or for amenities provided to an employee that are primarily personal in nature and that involve property or services not directly related to the employer’s trade or business, except to the extent that such benefits are treated as taxable compensation to an employee (or includible in gross income of a recipient who is not an employee).

The 50% limitation under current law also would apply only to expenses for food or beverages and to qualifying business meals under the Act provision, with no deduction allowed for other entertainment expenses. Further, no deduction would be allowed for reimbursed entertainment expenses paid as part of a reimbursement arrangement that involves a tax-indifferent party such as a foreign person or an entity exempt from tax. (Act Sec. 3307)

Effective date. The provision would be effective for amounts paid or incurred after 2017.

Unrelated business taxable income. Under the Act, tax-exempt entities would be taxed on the values of providing their employees with transportation fringe benefits, and on-premises gyms and other athletic facilities, by treating the funds used to pay for such benefits as unrelated business taxable income (UBTI), and so subjecting the values of those employee benefits to a tax equal to the corporate tax rate. (Act Sec. 3308)

Effective date. The provision would be effective for amounts paid or incurred after 2017.

Limitation on deduction for FDIC premiums.  amounts paid by insured depository institutions pursuant to an assessment by the Federal Deposit Insurance Corporation (FDIC) to support the Deposit Insurance Fund (DIF) are currently deductible as a trade or business expense. Under the Act, a percentage of such assessments would be non-deductible for institutions with total consolidated assets in excess of $10 billion. The percentage of nondeductible assessments would be equal to the ratio that total consolidated assets in excess of $10 billion bears to $40 billion, so that assessments would be completely non-deductible for institutions with total consolidated assets in excess of $50 billion. (Act Sec. 3309)

Effective date. The provision would be effective for tax years beginning after 2017.

Self-created property not treated as a capital asset. Under the Act, gain or loss from the disposition of a self-created patent, invention, model or design (whether or not patented), or secret formula or process would be ordinary in character. The election to treat musical compositions and copyrights in musical works as a capital asset would be repealed. (Act Sec. 3311)

Effective date. The provision would be effective for dispositions of such property after 2017

Repeal of numerous provisions. The Act would also repeal a variety of business provisions. It would repeal:

    • The deduction for local lobbying expenses, effective for amounts paid or incurred after 2017; (Act Sec. 3305)
    • The deduction for income attributable to domestic production activities, for tax years beginning after 2017; (Act Sec. 3306)
    • The rollover of publicly traded securities gain into specialized small business investment companies, effective for sales after 2017; (Act Sec. 3310)
    • The special rule treating the transfer of a patent prior to its commercial exploitation as long-term capital gain, effective for dispositions after 2017; (Act Sec. 3312)
    • The rule on the technical termination of partnerships; (Act Sec. 3313) and
  • The deduction for certain unused business credits, effective for tax years beginning after 2017. (Act Sec. 3405)

Business Credits

Credit for portion of employer social security taxes. Under the Act, the credit for a portion of the employer social security taxes paid with respect to employee tip would be modified to reflect the current minimum wage so that it is available with regard to tips reported only above the current minimum wage rather than tips above $5.15 per hour. In addition, all restaurants claiming the credit would be required to report to IRS tip allocations among tipped employees (allocations at no less than 10% of gross receipts per tipped employee rather than 8%), which is a reporting requirement now required only of restaurants with at least ten employees. (Act Sec. 3408)

Effective date. The provision would be effective for tips received for services performed after 2017.

Repeal of numerous credits. The Act would also repeal a variety of business credits. It would repeal:

    • The credit for clinical testing expenses for certain drugs for rare diseases or conditions, effective for tax years beginning after 2017; (Act Sec. 3401)
    • The employer-provided child care credit, effective for tax years beginning after 2017; (Act Sec. 3402)
    • The rehabilitation credit, generally for amounts paid or incurred after 2017. Under a transition rule, the credit would continue to apply to expenditures incurred through the end of a 24-month period of qualified expenditures, which would have to begin within 180 days after Jan 1, 2018; (Act Sec. 3403)
    • The work opportunity tax credit, effective for wages paid or incurred to individuals who begin work after 2017; (Act Sec. 3404)
    • The new markets tax credit—i.e., no additional new markets tax credits would be allocated after 2017, but credits that would have already been allocated may be used over the course of up to seven years as contemplated by the credit’s multi-year timeline; (Act Sec. 3406) and
  • The credit for expenditures to provide access to disabled individuals, effective for tax years beginning after 2017. (Act Sec. 3407)