News & Alerts
Tax Cuts and Jobs Act – the House GOP’s Tax Reform Bill
On November 2nd, the House Republicans released their version of tax reform that will bring significant changes to the U.S. Tax Code. The Act provides changes to both individual and business taxes. The Senate is expected to release their version of the tax bill on November 8th. The following are key business provisions of the House bill as currently written.
The Corporate Tax Rate will be Reduced to 20%
Currently, corporations are subject to graduated rates of 15% to 35%. Corporations with taxable income between $335,000 and $10,000,000 effectively are subject to a flat tax rate of 34% due to the phase out of the lower rates. Personal service corporations do not use the graduated rates and are taxed at a flat 35% rate.
The House Bill would implement a flat 20% rate for corporations and a flat 25% rate for Personal service corporations. These changes would be effective for tax years beginning after 2017.
Top Pass-Through Rate of 25% on Small Business Income with Certain Limitations
Currently, income from sole proprietors and pass through entities (partnerships and S corporations) are currently taxed at the individual tax rates with the top marginal tax rate of 39.6%.
The House Bill treats a portion of pass through income as business income subject to the maximum rate of 25%. The remaining portion of the pass through income would be treated under the current rules and subject to the individual ordinary tax rates. Pass through entities that are considered passive activities would be treated as business income and eligible for the maximum 25% rate. For non-passive pass through entities, the taxpayer may elect to apply a 30% capital percentage to the net business income to calculation the business income portion eligible for the maximum 25% rate. The remaining 70% of the income would be subject to the ordinary rates. The taxpayer is also given the option to calculate its own capital percentage based on a prescribed formula. The formula is based on a specified rate of return times the capital investments of the business. If a taxpayer elects to calculate its own capital percentage, the calculated amount would be binding for 5 years. Additional limitations would apply to the calculation of pass through income eligible for the maximum 25% rate.
Personal service businesses involving the performance of services in law, accounting, consulting, engineering, financial services or performing arts would have a 0% capital percentage resulting in none of the income be taxed at the maximum 25% rate. There is a provision that will allow a personal service business to use an alternative capital percentage based on capital investments.
This provision would be effective for tax years beginning after 2017.
Temporary 100% Bonus Depreciation for Qualified Business Property
Currently, businesses can claim additional depreciation at 50% of the cost for qualified property. The 50% provision for 2017 will be reduced to 40% in 2018 and 30% in 2019. In order to claim the additional depreciation, the original use of the property must begin with the taxpayer.
The House Bill would increase the bonus depreciation to 100% of the cost for qualified business property placed in service after 9/27/17 and before 1/1/23. In addition, the qualified property needs only to be the first use of the taxpayer. It does not have to be the first use overall. This would allow a taxpayer to claim 100% bonus depreciation on used property so long as it is the first time used by the taxpayer.
Increase in Section 179 Expensing
Currently, businesses may expense up to $500,000 of the cost of any section 179 property placed in service during the year. This amount is reduced if the taxpayer places more that $2 million of section 179 property in the taxable year. The deduction is further limited to taxable income for the year.
The House Bill would increase the expensing limit to $5 million and the phase-out of the deduction would be increased to $20 million. These amounts would also allow indexing of these amounts for inflation. The taxable income limitation would still apply. This change is effective for assets placed in service after 2017 and before 2023.
Limitation on Interest Expense
Currently, businesses can generally deduct interest expense paid or accrued in the tax year with certain limitations.
The House Bill subjects every business, regardless of its form, to a disallowance for net interest expense in excess of 30% of a business’ adjusted taxable income. Adjusted taxable income is a modified form of EBITDA considering a business’ taxable income computed without business interest expense, business interest income, net operating losses, depreciation, amortization and depletion. The disallowed interest amount would be carried over for 5 taxable years. An exception to this rule would be provided to businesses with average gross receipts of $25 million or less.
Repeal of Domestic Production Activities Deduction
Currently, qualifying taxpayers may claim a deduction equal to 9% of the lesser of the taxpayer’s qualified production activities income or the taxpayer’s taxable income for the year. The deduction is limited to 50% of wages paid by the taxpayer.
The House Bill repeals this deduction for tax years beginning after 2017.
No Deduction for Entertainment Expenses
Currently, a taxpayer may claim a 50% deduction for expenses related to entertainment, amusement or recreation activities if the taxpayer establishes that the item was directly related to the active conduct of the taxpayer’s trade or business.
The House Bill allows no deduction for entertainment, amusement or recreation activities even if directly related to the active conduct of the taxpayer’s trade or business. The repeal of this deduction is due to the difficulty by the IRS in determining if the expenses are directly related to the trade or business and the potential for abuse by the taxpayer. The 50% limitation under the existing law would still apply to food and beverage expenses and to qualifying business meals. This rule is effective for expenses paid or incurred after 2017.
Like Kind Exchanges Modified
Currently, no gain or loss is recognized on the sale or exchange of qualifying property if the property is exchanged for like-kind property and also used in the trade or business or investment. The taxpayer has 45 days to identify the replacement property and 180 days to receive the replacement property. If the like-kind exchange requirements are met, the gain on the sale of the property is deferred. Like-kind exchanges are commonly used for real property, business equipment and vehicles as well as other types of business or investment assets.
The House Bill modifies the like-kind exchange rules to only apply to real property. This would be effective for exchanges after 2017.
Repeal of WOTC
Currently, a taxpayer may also claim a 40% credit for qualifying first year wages of employees belonging to certain targeted groups (known as the Work Opportunity Credit).
The House Bill repeals this credit. This rule is effective for individuals who begin work after 2017.
The current House Bill is just one step in the process of passing tax law changes. The Ways and Means Committee will need to reach an agreement about the bill and it will then present a revised bill for Congress to vote on. Changes to the current version are expected. We will continue to provide updates as the proposed tax bill changes throughout the legislative process.