The Tax Cuts and Jobs Act
On December 22, 2017, President Trump signed the "An act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018." The bill had been entitled the "Tax Cuts and Jobs Act," but in yet another example of political dysfunction, the Senate cut the title from the bill. I will refer to the new law as the "act."
A lot of the media coverage of the Act had centered on the tax changes that affect us as individuals. The individual income tax brackets have been increased and the rates have mostly been lowered, with the new top rate being 37% versus 39.6%. Other significant changes are: elimination of personal exemptions; a $10,000 cap on itemized deductions of state and local taxes (including income, sales and property taxes); large increases in the standard deduction; a doubling of the child tax credit; a lower cap on the home mortgage interest deduction; and elimination of deductions for casualty losses and moving expenses.
A change that will have a tremendous impact on divorce negotiations is the treatment of alimony. Alimony paid pursuant to a court order entered after December 31, 2018, will no longer be deductible by the person paying the alimony and will no longer be income to the person receiving the alimony. For couples where one spouse was the sole or predominant breadwinner, this provision will likely greatly increase the total tax obligation of the divorced couple.
As dramatic as some of the changes in individual tax provisions are, the changes in business taxes are even more so. Again, the provision that has received the most coverage is the reduction of the corporate tax rate from 35% (one of the highest in the world) to 21%. However, the provision that will likely have the largest impact on small to medium sized businesses in the 20% deduction for pass through income.
The income of businesses that are taxed as sole proprietorships, partnerships and S corporations "passes through" to the individual owners. The owners then pay taxes on the income at their individual rates. Most small businesses are taxed in this way.
The Act creates a deduction for individuals of 20% of qualified business income from pass-through entities. For example, if a taxpayer owns a convenience store that is taxed as a partnership and her share of the income is $50,000, she can now deduct 20% of that income, or $10,000. The deduction does not apply to service businesses in the areas of health, financial and brokerage services, athletics, accounting, law, performing arts, consulting, or "any business where the principal asset is the reputation or skill of one or more of its employees," except for engineering and architecture. (Apparently the engineers and architects have the best lobbyists.) This deduction is not an itemized deduction, so it is still available to tax payers who take the standard deduction. Of course the deduction is not as simple as a straight 20% deduction. There are several limitations, and business owners will need to consult with a tax professional to determine exactly how the deduction will apply to them.
The limit on Section 179 deductions is increased from $500,000 to $1,000,000. Section 179 is the provision that allows a business to write of certain assets 100% in the year the asset is acquired rather than depreciating the asset over time.
The corporate alternative minimum income tax ("AMT") is repealed. The individual AMT is not repealed, but the exemption amount is increased.
Like-kind exchanges are now limited to real property. Overfly simplified, in a like-kind exchange, if a taxpayer sells an investment asset and invests the proceeds in a new investment asset, gain can be deferred until the new asset is sold. Like-kind exchanges in our area often involve farmland. If a farmer sells farmland but invests the proceeds in other farmland, he can defer the gain on the sale. Like-kind exchanges had also been available for certain types of personal property, but the Act eliminates that option.
Businesses can no longer deduct any entertainment costs. Fifty percent of entertainment costs were previously deductible. The fifty percent deduction for meals remains intact. The Act also provides that no deduction is available, "With respect to membership in any club organized for business, pleasure, recreation or other social purposes." Dues at country clubs have not been deductible for years, however, the prohibition on business club dues is new.
The treatment of net operating losses ("NOLs") has changed. Previously, a net operating loss could be carried back. For example, if your business made money in 2016 but lost money in 2017, you could amend your 2016 return deducting your 2017 losses and potentially receive a tax refund. NOLs can no longer be carried back. They can still be carried forward, but there is now an 80% limitation. For example, if your business looses $100,000 in 2018 and makes $100,000 in 2019, you can only deduct $80,000 of your 2018 NOL on your 2019 return.
The Act makes many more changes to individual and business taxation. You should consult a CPA or other tax advisor to determine how you can structure your finances to maximize opportunities and minimize negative consequences under the Act. You should consult them sooner rather than later, as the Act went into effect on January 1.