February 9, 2018
Source: Stanton B. Herzog, CPA and columnist, The Subject is Taxing!, The Representor
I have been asked to report on the new tax law. The law was passed so quickly that many technical questions remain unanswered. Most experts believe that a bill revising parts of the law will be required to clear up unaddressed questions. Here is the best I know so far.
The most significant and completely new idea is the creation of a 20 percent deduction for S corporation stockholders and members of partnerships and limited liability companies (LLCs), as well as sole proprietorships. The deduction is on the personal returns of the owners, not on the company at all. Apparently, it will be a deduction on the level of standard and itemized deductions after adjusted gross income. It will be based on the combined S corp. and partnership holdings. Things get more complicated from here. The 20 percent deduction is good for each tax return until the adjusted gross income reaches $157,000 for an individual return or $315,000 for a joint return. Above that income, a calculation is required and the reduction becomes:
The lesser of:
20% of the S corp. and partnership earnings (as above)
Or the greater of:
50% of the W-2 wages of the S corps and partnerships
25% of the W-2 wages, plus 2.5% of the original cost of all assets whose individual “applicable depreciation period” has not expired. For autos and computers and electronic items, the period is five years; furniture, seven years, for example. This is different from the actual depreciation allowed on the business tax return.
These figures will have to be supplied to all shareholder/partners on their form K-1s because the companies may not be in a position to know the income of the owners.
However, there is still another complication. Above the $157,000/$315,000 income level, the income from certain businesses will lose the deduction entirely over the next $100,000 of income. These are the usual suspects of professional corporations such as doctors and other health professionals, lawyers, accountants, consultants, athletes, brokers, etc. Specifically missing from this list are architects and engineers. BUT it includes businesses based upon the “reputation or skill of the employees or owners.” This presents an enormous problem: How could any business succeed if it was run by a bunch of morons? This phrase replaced a more specific reference in the “personal service” section to artists and performers.
I would like to believe that sales representatives would be excluded because their income is based upon commissions from sales, not personality or pure skill. Reps were definitely excluded from personal service corporations, but you just never know. Once again, under $157,000/$315,000 of income this is not a problem.
Moving on to other personal law changes.
The most significant is the limitation on the deductions for real estate taxes, state income and sales taxes to a combined maximum of $10,000 per return.
Congress further eliminated the miscellaneous deductions subject to the 2 percent of AGI limitation. These included a number of important deductions: broker fees, tax preparation fees, legal costs pertaining to finances, employee job costs — including courses to maintain and improve job skills — and employee expenses related to their jobs that were not reimbursed by their employers (e.g., entertainment and auto use). Employers may need to reevaluate their reimbursement and compensation policies to alleviate this tax burden on employees.
Also eliminated was the deduction for casualty losses except in the case of a federally stated disaster area. Your burglary, your fire — you own it.
The interest on new mortgage loans is limited to mortgages not exceeding $750,000,
down from $1,000,000. Deduction for home equity loan interest also was eliminated; this will affect a lot of individuals. One helpful factor is that the overall reduction of itemized deductions was again eliminated.
As you can see, itemized deductions have been decimated. Charity rules were unchanged. In fact, the maximum allowable deduction was increased from 50 percent of adjusted gross income to 60 percent. There is one important limitation: Excess portions of college football tickets will no longer be allowed as a charitable deduction. Non-two-percent miscellaneous deductions — like gambling losses — were also untouched.
To offset some of this, the standard deduction was doubled to $24,000. BUT the personal exemptions were eliminated. So people with one kid are already at a disadvantage. For a married couple with no children, the decrease in taxable income is a mere $2,300.
Alimony paid on divorces after Dec. 31, 2018, will no longer be deductible to the payer, and will not be taxable to the recipient. Just another item that will affect divorce decrees.
One of the more helpful parts of the law is the reduction of the Alternative Minimum Tax. Formerly the tax could have been incurred after $39,375 of income for single individuals and $84,500 for married couples. The new law raises these figures to $54,700 and $109,400 respectively. Further, there was a phase out which cut into the minimum level as income increased. That elimination does not start until income reached $500,000 for an individual and $1,000,000 on a joint return.
Finally, business losses on individual returns can no longer be carried back two years; such losses can only be carried forward. My personal reading is that such losses can still first offset current year income from all other sources. One of my sources indicates that the offset may be limited to 80 percent of taxable income. However, this remains a grey area because the law is not clearly written and the examples furnished do not adequately explore the situations.
The estate tax exemption was doubled to $11,200,000 of net assets at death per person.
Let’s discuss other business issues.
The corporation income tax rate has famously been reduced to a flat 21 percent. While large corporations sent up a cheer, it is important to realize that small corporations netting less than $50,000 per year have been paying 15 percent. This represents an INCREASE of 6 percent for them. I computed that such small firms would need a net income of over $90,000 per year before reaching parity with the new 21 percent rate. These firms should now consider Subchapter S status before March 15, 2018.
The special tax rate for service corporations (35 percent) was eliminated.
Entertainment has been completely eliminated beginning Jan. 1, 2018. The only deductible meals will be for employees on travel status and only at 50 percent.
Business assets have received super treatment for writeoff in the new law. For assets purchased before 2023, companies can write off 100 percent of their equipment purchases as bonus depreciation. The allowance is actually retroactive to Sept. 27, 2017. Beginning with 2023, the percentage drops by 20 percent per year until it reaches 0 on Jan. 1, 2027. This allowance includes vehicles over 6,000 pounds. In addition, for the first time, used property can use the bonus writeoff privilege. The privilege does not extend to property from a trade-in except for new cash, or to property bought from related parties.
Depreciation for automobiles under 6,000 pounds in 2018 is: $10,000 for year of purchase, $16,000 in year two, $9,600 in year three, and $5,760 annually thereafter.
Business interest expense could become a problem for larger businesses. Businesses with income in excess of $25 million, can only deduct interest to the extent of 30 percent of their taxable income plus interest income. Real estate businesses and auto financing are excluded.
The Domestic Activities Deduction has been terminated, along with corporation AMT.
Another somewhat significant provision is eliminating the “technical termination” of a partnership when the majority owner dies. This was a real downer for a partnership compared to a corporation, which is considered to have a life of its own. Partnerships can now continue per the tax code. I cannot comment on state laws.
There are many more provisions too technical to advance here. I have not addressed real estate changes and there may be re-interpretations of some of the items above. This is the best I can do right now.