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NEWS

NEWS

House Ways and Means Committee Release Tax Reform Bill

On November 2, Kevin Brady (R-TX), Chairman of the US House of Representatives' Ways and Means Committee, released the Tax Cuts and Jobs Act, a comprehensive tax reform proposal consisting of legislative language and a detailed explanation. He also announced that the Ways and Means Committee would begin consideration, or "markup," of the proposal on November 6. House Republican leaders' goal is to have the tax reform bill passed by the full House of Representatives and sent to the US Senate prior to the Thanksgiving holiday. 

Business Provisions

  • The corporate tax rate would be a flat 20%.  Personal service corporations would be subject to a flat 25% rate. 
  • The corporate alternative minimum tax would be repealed.
  • A portion of net income distributed by a pass-through entity (i.e., sole proprietorship, partnership, limited liability company (LLC) taxed as a partnership or S corporation) to an owner or shareholder may be treated as “business income” subject to a maximum rate of 25%, instead of ordinary individual income tax rates.  The remaining portion of net business income would be treated as compensation and continue to be subject to ordinary individual income tax rates.  Rules are provided to determine the proportion of business income and to prevent the re-characterization of actual wages paid as business income.  Net income derived from a passive business activity would be treated as business income and fully eligible for the 25% maximum rate.  Under certain default rules, owners or shareholders receiving net income derived from an active business activity (including wages received) would treat 70% of business income as ordinary income and 30% as business income eligible for the 25% rate; alternatively, such owners or shareholders may elect to apply a specified formula based on the business’s capital investments to determine an allocation greater than 30%.  Certain personal services businesses, such as law firms and accounting firms, would generally not be eligible for the reduced 25% rate on business income with respect to such personal services business, though they would be allowed to use the alternative formula based on the business’s capital investments, subject to certain limitations.
  • Businesses would be allowed to fully and immediately expense the cost of qualified property (not including structures) acquired and placed in service after September 27, 2017 and before January 1, 2023. 
  • “Section 179” small business expensing limitations would be increased to $5 million and the phase-out amount would be increased to $20 million, effective for tax years beginning after 2017 and before 2023.  These amounts would be indexed for inflation.  The definition of qualifying property would be expanded, effective for certain property acquired and placed in service after November 2, 2017. 
  • Businesses would have greater access to the cash method of accounting, including certain circumstances where a business has inventories. 
  • Every business, regardless of 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, e.g., at the partnership level rather than the partner level.  An exemption from this rule would be provided for small business with average gross receipts of $25 million or less.  Also, this provision would not apply to a real property trade or business.
  • The special rule under existing law allowing deferral of gain on like-kind exchanges would be modified to allow for like-kind exchanges only with respect to real property.
  • Numerous corporate deductions and credits would be repealed.  For example, the deduction for income attributable to domestic production activities would be repealed.  However, the research and development tax credit and the low-income housing credit would be retained.

International Provisions

  • The bill proposes significant changes to the taxation of business income earned outside the U.S. – including moving away from a deferral system to a “territorial” system.
  • It introduces a “participation exemption” system to the U.S. for the taxation of foreign income (similar to many European countries) whereby 100% of the foreign-sourced portion of dividends received from 10% or more owned foreign corporations would be exempt from U.S. tax.  No foreign tax credit would be allowed on any dividend qualifying for the participation exemption.
  • As a transition to this new system, the bill would deem a repatriation of previously deferred foreign earnings.
  • A current U.S. tax would be imposed on deferred earnings and profits of foreign corporations owned by 10% or greater U.S. shareholders. The rate would be 12% on earnings and profits (E&P) comprising cash or cash equivalents and 5% on the remaining E&P that has been reinvested in a foreign corporation’s business (e.g., property, plant and equipment).  An election is available to pay the tax in equal installments over a period of up to eight years.  Foreign tax credits would be partially available to offset the tax. 
  • If foreign E&P is taxed on transition to the participation exemption, the E&P can then be repatriated tax-free to the U.S. – subject to possible foreign withholding tax.
  • To address “base erosion,” a U.S. parent of one or more foreign subsidiaries would be subject to the 20% U.S. corporate tax rate on 50% of the U.S. parent’s “foreign high returns” (i.e., a 10% tax).  High returns would be measured as the excess of the subsidiaries’ income over a routine return (7% plus the federal short-term rate) on the subsidiaries’ bases in tangible property, adjusted downward for interest expense.
  • The deductible net interest expense of a U.S. corporation that is a member of an international financial reporting group would be limited to the extent the U.S. corporation’s share of the group’s global net interest expense exceeds 110% of the U.S. corporation’s share of the group’s global earnings before interest, taxes, depreciation and amortization (EBIDTA).
  • Payments (other than interest) made by a U.S. corporation to a related foreign corporation that are deductible, includible in costs of goods sold, or includible in the basis of a depreciable or amortizable asset would be subject to a 20% excise tax, unless the related foreign corporation elected to treat the payments as income effectively connected with the conduct of a U.S. trade or business.
  • There are also a number of other potentially impactful international tax provisions included in the bill that we will discuss in more detail in future commentary. 

Individual Provisions

  • The current seven tax brackets would be consolidated into four brackets of 12%, 25%, 35% and 39.6%.  For married taxpayers filing jointly, the 39.6% bracket threshold would be $1,000,000; in the case of unmarried individuals, it would be $500,000.
  • Personal exemptions would be eliminated and consolidated into a larger standard deduction --$24,000 for married taxpayers filing jointly and $12,000 for single filers. 
  • Most itemized deductions would be repealed, except for charitable contributions, up to $10,000 of state and local real property taxes and certain mortgage interest.  The deduction for interest on existing mortgages would continue, but for debt incurred after November 2, 2017, interest paid on only $500,000 of principal residence mortgage debt would be deductible.  Amongst the deductions repealed would be: state and local income or sales taxes, personal casualty losses, wagering losses, tax preparation expenses, medical expenses, alimony payments, moving expenses, contributions to medical savings accounts and expenses attributable to the trade or business of being an employee.
  • The bill would not change the current treatment of “carried interests.”
  • Pre-tax contribution levels for retirement accounts, such as a tax-deferred 401(k) account, would be retained.  
  • The individual alternative minimum tax would be repealed. 
  • The child care credit would be increased to $1,600 per child under 17; alternatively, a credit of $300 would be allowed for non-child dependents.  A family flexibility credit of $300 would be allowed with respect to a taxpayer (each spouse in the case of a joint return) who is neither a child nor a non-child dependent.  The refundable portion of the child credit would be limited to $1,000.  The family flexibility credit and the non-child dependent credit would be effective for taxable years ending before January 1, 2023.
  • The many existing provisions on education incentives would be consolidated and simplified.  Certain deductions and exclusions would be repealed.
  • The estate tax would be phased out over six years.  The “basic exclusion amount” would be doubled from $5 million (as of 2011) to $10 million, which is indexed for inflation ($10.98 million for 2017).  Beginning after 2023, the estate and generation-skipping tax would be repealed while maintaining a beneficiary’s step-up basis in estate property. 
  • Beginning in 2024, the gift tax is lowered to a top rate of 35% and retains a basic exclusion amount of $10 million and an annual exclusion of $14,000 (as of 2017), indexed for inflation.

20% Pass Through Deduction Available for Select Owners of LLCs,
S Corporations, Partnerships and Sole Proprietorships Under New Tax Act

The Tax Cuts and Jobs Act (TCJA) creates a brand-new tax deduction for owners of pass-through entities, including partners in partnerships, shareholders in S corporations, members of limited liability companies (LLCs) and sole proprietors.  However, this part of the tax code is so complex that even tax experts are challenged by it.

To begin, owners of pass-through entities are effectively taxed on earnings at individual tax rates similar to the way corporate owners are taxed on wages. Under the TCJA, tax rates for individuals are generally lowered over seven brackets, featuring a top tax rate of 37%. In contrast, C corporations will be taxed at a flat rate of 21%, which might be considerably lower than a business owner’s individual rate.

To balance things out, lawmakers have provided a deduction of up to 20% for pass-through entities on “qualified business income” (QBI), subject to certain limits and restrictions. QBI is generally defined as net income from your business without counting amounts in the nature of compensation (W-2 wages and guaranteed payments from LLCs and partnerships), in addition to excluding any investment income from the pass-through entity. Note that QBI is figured separately for each business activity rather than on a per-taxpayer basis.

But there are two main hurdles for claiming the full 20% deduction (referred to as “the deduction” throughout this article). The deduction may be reduced or even eliminated under a test for “specified service businesses” and a “wage and capital” limit.

  1. Specified service businesses: This includes virtually every occupation that provides a personal service other than engineering and architecture. If your taxable income exceeds a threshold of $157,500 for single filers and $315,000 for joint filers, the deduction is reduced pro-rata under the “phase-in rule.” The phase-in is complete when income reaches $207,500 for single filers and $415,000 for joint filers. Above these upper thresholds, you get no deduction.
  2. Wage limit and capital limit: The deduction is limited to the greater of (a) 50% of W-2 wages for your business or (b) the sum of 25% of W-2 wages and 2.5% of the unadjusted basis of all qualified business property (i.e. the cost basis of depreciable property available for use in your business). This limit is phased in pro-rata based on the same income thresholds as the ones stated above for personal service businesses. Once you exceed the upper threshold, the phase-in of the limit is complete.

Taxpayers who have income below the lower income threshold ($157,500 for single filers and $315,000 for joint filers) have no worries at all. They are entitled to the full deduction. However, individuals in certain service professions that are traditionally high-paid may not qualify for any deduction. The deduction for taxpayers in other businesses can vary widely.Business that qualify for the deduction means any trade or business other than any trade or business involving the performance of services in the fields of health, law,accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees. However, it does not include engineering or architecture.So if you don’t qualify for the deduction because you are a personal service business the trick would be to tax plan to get your income to be below the income threshold amounts above.

In addition, the deduction can’t exceed your taxable income for the year (reduced by net capital gain). If the net amount of your QBI is a loss, you can carry it forward to the next tax year.

The wage limits rules are designed to curb abuses, such as having business owners who do substantial work artificially reclassifying wages as QBI eligible for the deduction. Nevertheless, taxpayers may be tempted to establish themselves as independent contractors, further increasing the number of conflicts with the IRS on this issue. Independent contractor status has already been a point of contention in recent years.

The wage limit component discussed above presents issues for independent contractors, sole proprietorships and single member LLCs that are above the income thresholds of $157,500 for single filers and $315,000 for joint filersand that have no W-2 wages in that it eliminates the availability of the deduction all together.  One of the solutions to this would be to shift to an S corporation and re-characterize some of your compensation as W-2 wages.  

The 2.5% of the capital limit component discussed above presents a lucrative tax break for some, including wealthy owners of commercial property. This opens the deduction up to commercial property businesses, where there aren't a lot of workers, but there is a lot of valuable property around.  As discussed above, the pass-through caps can be eligible for the 20-percent deduction based on a formula: 50 percent of employee wages paid; or 25 percent of wages plus 2.5 percent of the value of qualified property at purchase, whichever is greater.  The idea is for these entities to use the sum of the '2.5 percent rule' plus 25 percent of wages to get the full 20-percent deduction.

In addition, the deduction is:

  • Done on a separate entity basis and not in the aggregate

  • Allowed for both regular and alternative minimum tax purposes

  • Allowed whether taxpayer is an active or passive owner in the business

  • Eliminated beginning after December 31, 2025

  • Available to both non-itemizers and itemizers.

With the C corporation tax rate lowered to 21% some lawmakers had predicted that the steep corporate tax cut would cause pass-through entities to convert to C corporations to take advantage of the lower rate.

That’s unlikely to come to pass, as S corporations, limited liability companies, and partnerships would likely continue to be advantageous structures for most businesses, despite the proposal to drop the corporate rate to 21 percent from 35 percent.  C corporations would face a lower rate under the tax plan, but C corporations face a second level of tax on the dividends distributed to investors. Pass-through status has become the entity of choice in recent decades because of the single layer of tax and a more malleable structure for distributing cash and assets.

These are just the basics on this complex new deduction. It is expected that the IRS will soon issue guidance for pass-through entities, especially regarding rules for re-characterization of wages. As the year unfolds, we will highlight strategies for maximizing the deduction under IRS-prescribed guidelines.

Individual Provisions of The Tax Cuts and Jobs Act

The following summarizes the key provisions of the Tax Cuts and Jobs Act (the Act) as it relates to individual taxpayers.  It should be noted that most of the provisions affecting individuals will expire starting in 2026.

Tax Brackets.  While one of the initial goals of tax reform was simplification of tax rates, there are now seven tax brackets instead of six. 

  • The top bracket is now 37% (down from 39.6%) and takes effect at $500,000 for single individuals and $600,000 for married taxpayers filing jointly.
  • Estates and trusts are subject to only four rates, with the top rate of 37% taking effect at $12,500.
  • Children under the age of 19 (or who are full-time students under the age of 24) are generally still subject to the “kiddie tax;” however, this is no longer tied to the income of either parents or siblings. Unearned income of children will now be subject to tax at the same rates as trusts and estates.
  • Capital gains and qualified dividends will still be eligible for preferential treatment and subject to rates of 0%, 15% and 20%.  Unrecaptured section 1250 gain will continue to be taxed at 25%, while gain on the sale of collectibles will remain at 28%. 
  • These rates are permanent except for the kiddie tax provision which does not apply to taxable years beginning after December 31, 2025.

Personal Exemptions and Standard Deduction.  Personal exemptions have been “suspended” until taxable years beginning after December 31, 2025.  The standard deduction has been “temporarily” increased to $12,000 for individual filers and $24,000 for married taxpayers filing jointly.  The increased amount of the standard deduction expires for taxable years beginning after December 31, 2025. 

Individual Alternative Minimum Tax (“AMT”).  For taxable years beginning after December 31, 2017 and before January 1, 2026, the AMT exemption is increased to $109,400 for married taxpayers filing jointly or half that amount for married individuals filing separately and $70,300 for all others (other than estates and trusts).  The phase-out thresholds are increased to $1,000,000 for married individuals filing jointly and $500,000 for all other taxpayers.

Child Tax Credits.  The child tax credit has been increased from $1,000 to $2,000 per qualifying child.  Only $1,400 per child is refundable.  Children age 17 and older are not eligible.

  • A $500 non-refundable credit is available for other dependents.
  • These credits phase out beginning with adjusted gross income of $400,000 for married taxpayers filing jointly and $200,000 for all others.
  • This provision expires for taxable years beginning after December 31, 2025.

Earned Income Credit, Lifetime Learning Credit, American Opportunity Credit, Deduction for Qualified Tuition and Related Expenses.  No changes have been made to existing law.

Education Related Provisions.  These provisions include the following:

  • Parents can use up to $10,000 per year from a Section 529 college savings plan towards tuition and qualified expenses for public, private, or religious elementary and secondary schools. 
  • The exclusion from income of student loan discharges and cancellation have been expanded for certain classes of debt (does not apply to discharges of debt after December 31, 2025).
  • Distributions or rollovers can be made between a Section 529 college savings plan and an ABLE account for certain disabled individuals.

Deduction for Taxes Not Paid or Accrued in a Trade or Business.  Subject to the exception below, in the case of an individual, state, local and foreign property taxes and local sales taxes are deductible only when paid or accrued in carrying on a trade or business or in connection with an activity for the production of income (i.e., deductible in computing income on Form 1040 Schedules C, E or F).  An individual can deduct such property taxes if they are imposed on business assets, such as residential rental property.  Similarly, in the case of an individual, state and local income taxes are not deductible, subject to the exception.

The deductions for state and local property taxes (not paid or accrued in carrying on a trade or business or in connection with an activity for the production of income) and state and local income taxes (or sales taxes in lieu of income taxes) have been combined into a single deduction and limited to $10,000 in the aggregate ($5,000 for a married taxpayer filing separately).  Foreign real property taxes are not deductible under this exception. 

These rules apply to taxable years beginning after December 31, 2017 and before January 1, 2026. 

The conference agreement provides that prepayments for anticipated 2018 state and local income taxes made in 2017 are to be treated as made on December 31, 2018 and, therefore, are not allowed as deductions on a 2017 return.

Home Mortgage Interest.  The deductibility of interest on current mortgages of up to $1,000,000 ($500,000 in the case of married taxpayers filing separately) of principal indebtedness remains.  However, in general, for new mortgages entered into between December 15, 2017 and December 31, 2025, this limit is reduced to $750,000 ($375,000 for married taxpayers filing separately).  For taxable years beginning after December 31, 2025, the limit reverts to $1,000,000 ($500,000 for married taxpayers filing separately), regardless of when the indebtedness was incurred. The deduction for home equity interest is suspended, effective for taxable years beginning after December 31, 2017 and before January 1, 2026.

Charitable Contributions.  The income-based percentage limit for certain charitable contributions by an individual taxpayer of cash to public charities and certain organizations is increased from 50% to 60% of adjusted gross income, effective for charitable contributions made in taxable years beginning after December 31, 2017 and before January 1, 2026.

Medical Expenses.  There is a temporary reduction in the medical expense deduction floor to include costs that exceed 7.5% of adjusted gross income (rather than the 10% under current law).  This applies for taxable years beginning after December 31, 2016 and before January 1, 2019.

Alimony Payments.  The deduction for alimony is repealed (as well as the inclusion in income of alimony received).  This provision is effective for any divorce or separation instrument executed after December 31, 2018, subject to rules governing modifications.

Moving Expenses.  Subject to a limited exception, this deduction is suspended, effective for taxable years beginning after December 31, 2017 and before January 1, 2026.  The exclusion from gross income and wages for qualified moving expense reimbursement (except for certain Armed Forces-related moving expenses and reimbursement) is also suspended, for taxable years beginning after December 31, 2017 and before January 1, 2026.

Personal Casualty and Theft Losses.  Effective for losses in taxable years beginning after December 31, 2017 and before January 1, 2026, this deduction is repealed except for losses incurred as a result of certain federally declared disasters.  Also, special relief rules apply with respect to 2016 major disasters, as to personal casualty losses and the use of retirement funds.

Miscellaneous Itemized Deductions Subject to 2% Floor.  All miscellaneous itemized deductions subject to the 2% floor under current law are repealed, for taxable years beginning after December 31, 2017 and before January 1, 2026.

Limitation on Itemized Deduction (3% Limitation).  The 3% limitation is repealed, for taxable years beginning after December 31, 2017 and before January 1, 2026. 

Affordable Care Act Individual Shared Responsibility Payment.  Under the terms of the Affordable Care Act, individuals must be covered by a health plan that provides at least a specified minimum coverage or be subject to a tax (penalty) for failure to maintain the coverage (often referred to as the “individual mandate”), subject to certain exemptions.  The requirement for this payment is eliminated, i.e., would reduce the amount of the shared responsibility payment to zero.  This applies to health care coverage status for months beginning after December 31, 2018.

Estate and Gift Tax Exemption.  The estate and gift tax exemption is doubled, accomplished by increasing the basic exclusion amount from $5 to $10 million.  The $10 million exclusion amount is indexed for inflation after 2011 ($10.98 million for 2017).  The proposal is effective for decedents dying, generation skipping transfers and gifts made after December 31, 2017.  The increase in the basic exclusion amount expires for decedents dying and gifts made after December 31, 2025. 

Key Business Provisions of The Tax Cuts and Jobs Act

The following summarizes the key provisions of the Tax Cuts and Jobs Act (the Act) as it relates to businesses. 

Corporate Tax Rate Reduction.  For taxable years beginning after December 2017, the corporate tax rate is a flat 21%. The 21% tax rate also applies to personal service corporations. It appears that the rate will be pro-rated for fiscal year filers if the taxable year includes January 1, 2018.

Dividend Received Deductions.  The 80% dividends received deduction is reduced to 65% and the 70% dividends received deduction to 50%.

Corporate Alternative Minimum Tax.  The corporate AMT is eliminated.  Taxpayers that have AMT credit carryforwards will be able to use them against their regular tax liability and will also be able to claim a refundable credit equal to 50% of the remaining AMT credit carryforward in years beginning in 2018 through 2020 and 100% for years beginning in 2021.

Pass Through Entities.  The Act generally allows a non-corporate taxpayer (including a trust or estate) who has qualified business income (“QBI”) from a partnership, S corporation or sole proprietorship (pass-through entities) to deduct the lesser of:

  • The combined QBI amount of the taxpayer; or
  • 20% of the excess, if any, of the taxpayer’s taxable income for the tax year, less net capital gain.

QBI is defined as all domestic (U.S.- source, including Puerto Rico) business income other than investment income.  QBI does not include any amount that is treated as reasonable compensation of the taxpayer for services rendered to the business (W-2 salary for S corporation) or any amount paid by a partnership that is a guaranteed payment for services performed. The 20% deduction is not allowed in computing adjusted gross income, but rather is allowed as a deduction reducing taxable income.

Limitations

For pass-through entities, the deduction cannot exceed the greater of:

  • 50% of the W-2 wages attributable to QBI paid to the taxpayer; or
  • The sum of 25% of the W-2 wages with respect to the qualified trade or business, plus 2.5% of the unadjusted basis of all qualified property.

Qualified property is generally defined as tangible, depreciable property that is held by, available for use, and used in the qualified trade or business at the close of the taxable year.

For a partnership or S corporation, each partner or shareholder is treated as having W-2 wages for the taxable year in an amount equal to his or her allocable share of the entity’s W-2 wages for the tax year.

The W-2 wage limit does not apply in the case of a taxpayer with taxable income not exceeding $315,000 for married individuals filing jointly ($157,500 for other individuals). This limitation is phased-in for individuals with taxable income exceeding these thresholds over the next $100,000 of taxable income for married taxpayers filing jointly ($50,000 for other individuals).

Thresholds and Exclusions

The deduction does not apply to “specified service businesses,” which means any trade or business that involves the performance of services for any trade or business where the principal asset of such trade or business is the reputation or skill of one or more employees or owners.  These include the areas of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, and brokerage services.

The Act specifically excludes engineering and architecture services from the definition of specified service business.  This exclusion does not apply for a taxpayer whose taxable income does not exceed $315,000 for married individuals filing jointly ($157,500 for other individuals). The deduction for service businesses is phased out over the next $100,000 of taxable income for joint filers ($50,000 for other individuals).

Excess Business Losses of Taxpayers Other than Corporations.  The Act implements a new rule, which states that “excess business losses” of a taxpayer other than a corporation are not allowed for the taxable year but are instead carried forward and treated as part of the taxpayer's net operating loss (“NOL”) carryforward in subsequent tax years. This limitation applies after the application of the passive activity loss rules.  NOL carryovers generally are allowed for a taxable year up to the lesser of the carryover amount or 80% of taxable income.

An excess business loss for the taxable year is the excess of the taxpayer’s aggregate deductions attributable to his/her trade and businesses over the sum of aggregate gross income or gain of the taxpayer, plus a threshold amount. The threshold amount for a taxable year is $500,000 for married taxpayers filing jointly and $250,000 for other individuals, with both amounts indexed for inflation.

Increased Bonus Depreciation.  Businesses are generally allowed to write off (expense) a percentage of the cost of depreciable assets that are acquired and placed in service from September 28, 2017 to December 31, 2026.  The write-off percentages are as follows:

9/28/17 to 12/31/22 100%
2023 80%
2024 60%
2025 40%
2026 20%

Depreciation Limitation for Luxury Automobiles and Personal Use Property.  For passenger automobiles placed in service after December 31, 2017 and for which bonus depreciation is not claimed, the luxury automobile depreciation limitation is increased to a maximum of $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year and $5,760 for the fourth and later years.  The limitations are indexed for inflation for automobiles placed in service after 2018.
Section 179 Expensing.  The “Section 179” small business expensing limitation is increased to $1,000,000, and the phase-out threshold is increased to $2,500,000, effective for property placed in service in taxable years beginning after December 31, 2017.  These amounts are indexed for inflation.  The definition of qualifying property is expanded to include certain improvements to real property.

Recovery Period for Real Property.  The provision eliminates the separate definitions of qualified leasehold improvement, qualified restaurant and qualified retail improvement property and provides a straight-line, 15-year recovery period for qualified improvement property and a 20-year “alternative depreciation system” (“ADS”) recovery period for such property.  The ADS recovery period for residential rental property is reduced from 40 to 30 years. Both of these rules are effective for property placed in service after December 31, 2017. The recovery period for nonresidential real and residential rental property remains at 39 and 27.5 years, respectively. 

Computers and Peripheral Equipment Removed from Listed Property.  Deductions for such property are no longer subject to the heighted substantiation requirements.

Accounting Simplification for Small Businesses.  For certain businesses with not more than $25 million in average annual gross receipts (indexed for inflation), the following accounting simplifications apply:

  • Cash Method of Accounting.  C corporations and partnerships with C corporation partners will be able to use the cash method of accounting.  Currently, the gross receipts limitation is $5 million. 
  • Accounting for Inventories.  A business will be able to use the cash method of accounting even though it has inventory.  The business will have to treat the inventory as non-incidental materials and supplies or conform to the taxpayer’s financial accounting treatment of inventories. 
  • Capitalization and Inclusion of Certain Expenses in Inventory Costs.  Businesses will be fully exempt from the UNICAP rules for real and personal property, acquired or manufactured.
  • Long-Term Contract Accounting.  Businesses that meet the threshold will be able to use a non-percentage of completion method including the completed contract method.

Accounting Methods/Special Rules for Taxable Year of Inclusion.  This provision revises the rules associated with the recognition of income.  For taxable years beginning after December 31, 2017, it requires a taxpayer to recognize income no later than the taxable year in which such income is taken into account as income on an applicable financial statement, subject to an exception for certain long-term contract income.

Deferral Method for Advanced Receipts.  This codifies the current deferral method of accounting for advance receipts for goods and services under an IRS revenue procedure; i.e., taxpayers will be allowed to defer the inclusion of income associated with certain advance receipts to the end of the taxable year following the tax year of receipt if such income also is deferred for financial statement purposes.

Interest Expense Deduction.  For taxable years beginning after December 31, 2017, the deduction for business interest is limited to the sum of business interest income, floor plan financing interest, and 30% of the “adjusted taxable income” of the taxpayer for the taxable year.  The adjusted taxable income is the taxable income of the taxpayer computed without regard to (i) any item of income, gain, deduction or loss which is not properly allocable to a trade or business; (ii) any business interest or business interest income; (iii) the 20% deduction for certain pass-through income; (iv) for taxable years beginning after December 31, 2017 and before January 1, 2022 -- depreciation, amortization, or depletion; and (iv) the amount of any net operating loss deduction.  The amount of disallowed interest is carried forward indefinitely.  Exempt from these are businesses with average gross receipts of $25 million or less, regulated public utility companies, electing real property trade or businesses, and electing farming businesses.

Net Operating Loss Deduction.  The NOL deduction is limited to 80% of taxable income (determined without regard to the NOL deduction), effective for losses arising in taxable years beginning after December 31, 2017. 

Carryovers to other years are adjusted to take account of this limitation and can be carried forward indefinitely.  The two-year carryback and certain special carryback provisions are repealed except for certain farming businesses and property and casualty insurance businesses.  The provisions to limit carrybacks and allow indefinite carryforwards applies to losses arising in taxable years beginning after December 31, 2017.

Like-Kind Exchanges of Real Property.  The like-kind exchange rules are only available for real property not held primarily for sale.  The rule is for transfers after 2017 but a transition rule applies to any exchange if either the property being exchanged or received is exchanged or received on or before December 31, 2017.

S Corporation Conversions to C Corporations.  In the case of an S corporation which revokes its S corporation election during the two-year period beginning on the enactment date (of this legislation) and has the same owners on both the enactment date and the revocation date, distributions from the terminated S corporation are treated as paid from its accumulated adjustments account and from its earnings and profits.  Adjustments attributable to the conversion from S corporation status to a C corporation (IRC Sec. 481(a)) are taken into account ratably over six years.

Repeal of Certain Business Expenses.  The following business deductions are repealed:

  • The IRC Sec. 199 domestic production activity deduction (“DPAD”) for taxable years beginning after December 31, 2017.
  • The deduction for entertainment expenses other than business meals. Taxpayers will still generally deduct 50% of the food and beverage expenses associated with operating their trade or business.  For amounts incurred and paid after December 31, 2017, and until December 31, 2025, the 50% limitation applies to expenses of the employer associated with meals provided for the convenience of the employer on the employer’s business premises, or provided on or near the employer’s business premises through an employer-operated facility that meets certain requirements: such amounts paid or incurred after December 31, 2025 are not deductible.

Local Lobbying Expenses.  Deductions for lobbying expenses with respect to legislation before local government bodies are disallowed, effective for amounts paid or incurred on or after the date of enactment.

Amortization of Research and Experimental Expenditures.  Specified research or experimental expenditures, including software development expenditures, are capitalized and amortized over a five-year period (15 years if attributable to research conducted outside of the United States).  This provision applies on a cut-off basis to expenditures paid or incurred in taxable years beginning after December 31, 2021. 

Research and Development Credit.  As indicated in Policy Highlights published by the Conference Committee, the credit is preserved.

Modification of Limitation on Excessive Employee Compensation.  Applicable to taxable years beginning after December 31, 2017, the exception to the $1 million deduction limitation for commissions and performance-based compensation in the case of publicly held corporations is repealed.  The definition of covered employee is amended to include the principal executive officer, the principal financial officer and the three other highest paid employees.  Once an employee qualifies as a covered employee, his/her compensation is subject to the $1 million limitation as long as the executive (or beneficiary) receives compensation from the company.  There is a transition rule for written binding contracts in effect as of November 2, 2017 not modified thereafter in any material respect.

Denial of Deduction for Settlements Subject to Nondisclosure Agreements Paid In Connection with Sexual Harassment or Sexual Abuse.  No deduction is allowed for any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or for attorney’s fees related to such settlement or payment.  This provision applies to amounts paid or incurred after the date of enactment.

Deductibility of Fines and Penalties for Federal Income Tax Purpose.  No deduction is allowed for any amount paid or incurred to, or at the direction of, a government or governmental entity in relation to the violation of any law or the investigation or inquiry by that government or entity into the potential violation of any law. Certain exceptions apply.