The Tax Cuts and Jobs Act (TCJA) is long and complicated. Its effects will vary from business to business, depending on each one's structure and the nature of its operations. Here are four major changes that are likely to save taxes for domestic manufacturers.
- Lower Tax Rate for C
The TCJA permanently lowers the federal income tax rate for C corporations to a flat 21%. The low, flat tax rate is good news if your business earns enough taxable income to have fallen into the 25%, 34% or 35% bracket under prior law. But, it is bad news if you would have fallen into the 15% bracket.
Fortunately, there is at least one silver lining for smaller manufacturers that would have otherwise been in lower tax brackets. The TCJA liberalizes the eligibility requirements for smaller businesses to qualify for the cash method of accounting.
This method generally provides greater flexibility in tax planning by deferring revenue recognition and accelerating expense recognition, compared to the accrual method of accounting. In addition, the TCJA liberalizes the eligibility requirements for small businesses to use simplified inventory accounting methods.
- Lower Tax Rates for Individual Owners
of Pass-Through Entities
There is good and bad news for owners of pass-through entities, such as sole proprietorships, partnerships, S corporations and limited liability companies (LLCs). The bad news is that tax cuts for individuals are relatively modest, and they are only available through 2025.
A key upside is that individual owners of many manufacturing companies will qualify for a new deduction of up to 20% of qualified business income (QBI). This break is intended to help achieve parity between the tax rates for C corporations and pass-throughs under the TCJA. But, it is available only through 2025 and it is subject to many rules and restrictions.
The limitations that are most likely to hit manufacturers relate to W-2 wages and the basis of qualified property. The QBI deduction is generally limited to the greater of an owner's share of 1) 50% of the amount of W-2 wages paid to employees by the business during the tax year, or 2) the sum of 25% of W-2 wages plus 2.5% of the cost of qualified property.
So, the QBI deduction for pass-through owners with few W-2 employees and/or limited fixed assets may be partially phased out. However, these limitations do not kick in until the individual owner's taxable income (calculated before any QBI deduction) exceeds $157,500, or $315,000 for a married owner who files jointly.
- Changes to the AMT Rules
The TCJA permanently repeals the corporate alternative minimum tax (AMT). Under prior law, corporations faced an AMT rate of 20% of AMT income above an exemption amount, minus any AMT foreign tax credit.
In addition, the new law temporarily increases the AMT exemption amounts for individuals through 2025. As a result, fewer owners of pass-through businesses will owe the AMT starting in 2018, and those that do will generally owe less than they would have under prior law.
- Expanded Sec. 179 and Bonus
For qualifying property placed in service in tax years beginning after December 31, 2017, the maximum Section 179 deduction permanently increases to $1 million (up from $510,000 for tax years beginning in 2017). In addition, the Sec. 179 deduction phaseout threshold increases to $2.5 million (up from $2.03 million for tax years beginning in 2017). These amounts will be adjusted annually for inflation. The TCJA also expands the definition of eligible Sec. 179 property.
Additionally, the first-year bonus depreciation program has become much more generous under the TCJA. For qualified property placed in service between September 28, 2017 and December 31, 2022, the first-year bonus depreciation percentage on qualifying new and used property increases to 100% (up from 50% in 2017). First-year bonus depreciation is scheduled to be reduced as follows:
- 80% for property placed in service in calendar year 2023;
- 60% for property placed in service in calendar year 2024;
- 40% for property placed in service in calendar year 2025; and
- 20% for property placed in service in calendar year 2026.
For certain property with longer production periods, the preceding cutbacks are delayed by one year.
These key changes are just the tip of the iceberg. The TCJA may significantly alter income tax obligations for your business's current tax year. If you have additional questions about the effects of tax reform, contact a tax professional.
Sidebar: The dark side of tax reform
Several provisions of the Tax Cuts and Jobs Act (TCJA) are unfavorable to businesses. Specifically, manufacturers should watch out for new limits on:
- Interest expense deductions;
- Net operating losses (NOLs);
- Deductions for business entertainment; and
- Certain transportation-related employee benefits.
In addition, the TCJA repeals the domestic production activities deduction under Section 199. Starting in 2022, manufacturers will be required to capitalize and amortize specified research or experimental expenditures, rather than to expense them immediately.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.